Budgetary Control 



By 
JAMES O. McKINSEY, A.M., LL.B. 

Certified Public Accountant; Member of the 

firm of Frazer & Torbet; Assistant Professor 

of Accounting, University of Chicago 




NEW YORK 

THE RONALD PRESS COMPANY 

1922 






Copyright, 1922, by 
The Ronald Press Company 



All Rights Reserved 



m -3 1^22 



©Ci.A677770 



aaC I 



/ 



PREFACE 

Although much has been written of budgetary control 
as applied to particular phases of a business, this is the first 
attempt, so far as the author is aware, to present the sub- 
ject as a whole, and cover the entire budgetary program. 
It is to be regarded as an effort to state clearly the problems 
involved, rather than to offer full solutions. It is hoped 
that the discussion will stimulate thought, and constructive 
criticism will be gladly received. ^ i> 

One obvious difficulty has been the problem of what to "^ 
include and what to omit. The budgetary procedure in- 
volves administrative policies on the one hand, and admin- 
istrative routine on the other. The discussion might easily 
cover the whole field of business administration, ranging 
over a wide variety of topics about which no one individual 
can be expected to have expert knowledge. In the present 
work, however, the reader is addressed throughout, not as a 
technical expert, but rather as a student of the broad prob- 
lem of administration. The advertising man, for example, 
may be aided in handling his own problems through under- 
standing the method of applying budgetary control to the 
operations of all other departments of the business, as ex- 
plained in the other chapters of the book. So with the other 
departmental executives ; it is hoped that each of them will . 
be helped by a comprehensive picture of the problem as a 
whole. The discussion has been kept sufficiently elemen- 
tary, it is believed, to be easily understandable by those who 
are not experts on the technical subjects discussed. 

With this thought in mind, there has been no effort to 
prescribe an arbitrary procedure. In some cases, assump- 
tions have been made and definite procedures discussed, but 

iii 



IV PREFACE 

only for the purpose of making the treatment concrete ; the 
definite procedures given are intended to be suggestive only. 
Similarly, the various forms given are merely indicative. 
All of them have been used by the author at some time in 
his professional practice, but he by no means regards them 
as standard forms. He has found it necessary to design 
forms to meet each particular case. 

Finally, no attempt has been made to discuss in detail 
the many problems which may arise in the installation and 
operation of budgetary control. To do so would be to make 
the volume less useful to those for whom it is primarily in- 
tended. It is thought that the reader who has a compre- 
hensive picture of the entire problem will be able to make 
his own applications and to work out the special adjust- 
ments required for his own situation. 

The text is based primarily on the rather wide experience 
of the author in professional work, but material assistance 
has been received from various business men, accountants, 
and instructors. Particular acknowledgment is due to the 
following: Mr. W. V. Lindblom, executive in charge of the 
budgetary procedure of the Walworth Manufacturing Com- 
pany, and Mr. Albert S. Keister, Lecturer on Business 
Finance, University of Chicago, who have read all the 
manuscript and given many useful suggestions; Mr. N. L. 
McCully, executive in charge of the budgetary procedure of 
the Lewis Manufacturing Company, who prepared the 
chart on budgetary procedure given in Chapter XXIII ; and 
Mr. George E. Frazer, C.P.A., the author's partner, to 
whose counsel and assistance the author is especially in- 
debted. 

James O. McKinsey 
Chicago, Illinois, 

June 20, 1922 



CONTENTS 



Chapter Page 

I The Meaning of Budgetary Control ....... 3 

II The Need for Budgetary Control 12 

III Preliminary Steps in Installation 28 

IV Organization for Budgetary Control ....... 43 

V The Sales Budget 54 

VI The Sales Budget (Continued) 71 

VII The Selling Expense Budget 87 

VIII The Advertising Budget 106 

IX The Production Budget 124 

X The Materials Budget 145 

XI The Labor Budget 165 

XII The Welfare Expense Budget . 178 

XIII The Manufacturing Expense Budget 188 

XIV The Purchases Budget 210 

XV The Purchases Budget (Continued) 228 

XVI The Plant and Equipment Budget 245 

XVII The Plant and Equipment Budget (Continued) ... 261 

XVIII The Expense Budgets 273 

XIX The Financial Budget 295 

XX The Financial Budget (Continued) 316 

XXI The Estimated Balance Sheet 333 

XXII The Estimated Statement of Profit and Loss. . . 359 

XXIII Manual of Budgetary Procedure 374 

XXIV Administrative Reports 396 

XXV Advantages and Limitations of Budgetary Control 416 

XXVI Budgetary Control for Non-Commercial Enter- 
prises 425 

Appendix A — ^The Budget and Accounting Act 439 

B — Administrative Code for the State of Ohio . . 450 

C — A Trust Company Budget System 456 

V 



ILLUSTRATIONS 



Figure * Page 

1. Chart Showing Corporate Form of Organization 21 

2. Form Showing Factory Requirements for Use in Preparing Sales 

Estimate 73 

3. Selling Expense Budget 103 

4. Report on Selling Expense Budget 103 

5. Advertising Appropriation Report 117 

6. Advertising Appropriation Report (monthly cumulative) 121 

7. Advertising Expenditures Report 122 

8. Monthly Finished Stock Budget Report 141 

9. Balance of Stores Sheet 153 

10. Materials Budget 161 

11. Periodic Materials Budget Report 161 

12. Labor Budget 175 

13. Monthly Labor Budget Report 175 

14. Welfare Expense Budget 185 

15. Monthly Welfare Expense Report 185 

16. Manufacturing Expense Budget 205 

17. Monthly Manufacturing Expense Report 205 

18. Schedule of Deliveries to Stock 221 

19. Monthly Report on Purchases Budget 225 

20. Estimate of Purchases Disbursements 231 

21. Showing Merchandise Plan of Each Department of a Department 

Store 239 

22. Plant Ledger 254 

23. Plant and Equipment Budget 263 

24. Monthly Report on Appropriations for Plant and Equipment. . . 269 

25. Organization Chart for a Manufacturing Business 275 

26. Another Form of Organization for a Manufacturing Business . . . 277 

27. Expense Budget 292 

28. Monthly Expense Appropriation Report 293 

29. Graph Showing Accumulated Sales and Collections 304 

30. Estimate of Cash Receipts 308 

31. Simple Estimate of Cash Disbursements 311 

32. More Elaborate Estimate of Cash Disbursements 313 

33. Summary of Financial Requirements 317 

34. Financial Program for Bank Loans 318 

35. Monthly Collections Report 321 

36. Monthly Cash Receipts Report 322 

37. Monthly Cash Disbursements Report 323 

38. Balance Sheet 339 

39. Comparative Balance Sheet, with Preliminary Estimate 351 

40. Comparative Statement of Profit and Loss, with Preliminary Esti- 

mate 363 

41. Comparison of Actual and Estimated Balance Sheets 369 

42. Comparison of Actual and Estimated Statements of Profit and Loss 371 

43. Chart of Budget Procedure (opposite) 394 

44. Monthly Sales Report 402 

vii 



Viil ILLUSTRATIONS 

45. Monthly Selling Expense Report 403 

46. Monthly Net Profits Report 405 

47. Monthly Stock Report 407 

48. Monthly Comparative Summary 408-409 

49. Monthly Summary of Operations 412 

50. Monthly Group Pound Cost 413 

51. Monthly Factory Inventories Report 414 

52. Departmental Salary Budget of a University • 434-435 

A Trust Company Budget System (Appendix C) 

Monthly Summary of Expenses 459 

Monthly Expenses of Securing Business 460 

Monthly Expenses of Transacting Business — Main Office . . . 461-462 

Yearly Summary of Expenses 463 

Request for Appropriation 464 

Yearly Appropriation Sheet 465 



Budgetary Control 



CHAPTER I 
THE MEANING OF BUDGETARY CONTROL 

Planning of Business Operations 

That comprehensive planning is necessary for efficient 
administration may be regarded as an axiom of the present- 
day philosophy of business administration. Business 
executives have come to realize that they can perform 
properly the tasks of today only if they have already 
planned those tasks yesterday, and planned also the tasks 
of tomorrow. There are many who do not yet plan 
scientifically, but there are few who will deny the merits 
of the system. 

The planning which may be done in connection with any 
particular business may be classified into three broad over- 
lapping groups : 

1. That which deals with the operations of the separate depart- 

ments, such as production, sales, and finance. Such planning 
has been described loosely in the past, as "industrial engineer- 
mg. 

2. That which deals with the coordination of the operations of the 

several departments to the end that a well-formulated program 
may be made, for the business as a whole. Such planning 
may well be termed "budgetary control." 

3. That which deals with the determination of future conditions as 

reflected in the business cycle and the shaping of the plans of 
the business to meet these conditions. Such planning is known 
as "forecasting" or "business predicting." 

While the discussion in the following pages is restricted 
primarily to a consideration of planning of the second kind, 
it must be realized of course that these various kinds of 
plans are all very closely related and must be coordinated if 

3 



1/ 



4 BUDGETARY CONTROL 

proper results are to be obtained. The budgetary plans are 
vitally affected by the business cycle, and the departmental 
plans are equally affected by the budgetary plan. The 
reader will notice that in the following pages it will be neces- 
sary to discuss to some extent all three kinds of planning. 

Popular Conception of Budgetary Control 

In the past, budgetary control has been considered pri- 
marily in connection with governmental units. There has 
been much discussion of the "budgets" of cities and states, 
and during recent years much interest has been manifested 
in the budget of the national government. This interest 
has been greatly increased by the passage of the National 
Budget Act and the submission to Congress of the first 
budget prepared under this act. The budgets of govern- 
mental units are discussed frequently in the daily press and 
by aspirants for political office, and are thus called constantly 
to the attention of the public. As a consequence many 
people have come to think of budgetary control as an instru- 
ment for governmental administration. Not only is this the 
popular view but practically all the literature on budgetary 
control is confined to a discussion of governmental budgets. 

Although practically all people who have given thought 
to the subject will admit that there should be budgetary 
control of public finances, very few have thought of budg- 
etary control with reference to the individual business unit. 
It is the purpose of these chapters to show that the principles 
of budgetary control are as applicable to the individual 
business unit as to the governmental unit, and to explain 
the method by which these principles may be applied. As 
a first step it is necessary to see (i) what budgetary control 
is, and (2) why it is needed in business administration. The 
present chapter and the chapter immediately following will 
be devoted to a consideration of these topics. 



THE MEANING OF BUDGETARY CONTROL 5 

Procedure for Budgetary Control 

Probably the best way to show "what budgetary control 
is" is to outline how it operates. The procedure to be fol- 
lowed by a business firm in the installation and operation of 
budgetary control will of necessity vary, depending pri- 
marily on the organization of the business and the nature of 
its operations. A possible procedure, stated briefly and in 
outline form, is as follows: 

1. Each department prepares an estimate of its activi- 
ties for the budget period. The method of stating these 
activities depends on the nature of the operations of the de- 
partment, the sales department stating the sales it expects 
to make and the estimated expenses it will incur in making 
these sales ; the production department stating the estimated 
production for the period and the estimated requirements 
in materials, labor, and manufacturing expenses to meet this 
estimate; the service departments, such as the personnel 
department, the traffic department, the accounting depart- 
ment, and the office raanager's department, stating the esti- 
mated expenditures of their departments. Because of the 
interdependence of these departments, some will need to 
use the estimates of other departments in making their own 
estimates. For instance, the production department must 
know the estimated sales before it can estimate the produc- 
tion necessary to meet the sales demands; the treasurer 
must know the plans of all the departments before he can 
estimate his cash receipts and cash disbursements. Con- 
sequently a procedure must be set up which provides for a 
proper scheduling of the estimates with reference to prepa- 
ration and distribution. 

2. The departmental heads will transmit the depart- 
mental estimates to an executive who has supervision of the 
budgetary procedure. Sometimes the controller acts in 
this capacity, while in many cases the duty is delegated to a 



6 BUDGETARY CONTROL 

member of the staff of the general manager or president. 
Since many businesses do not have a controller, it will be 
assumed during the present discussion that an assistant to 
the president acts in this capacity. This official combines 
the estimates of all the departments into a proposed finan- 
cial budget for the business. In preparing this estimate he 
will be assisted by the treasurer, though in some cases this 
budget is prepared by the treasurer alone. The proposed 
financial budget should show the estimated receipts from 
all sources and the estimated expenditures by all depart- 
ments of the business. 

3. The executive in charge of the budget procedure 
makes a comparison between the estimated receipts and the 
estimated expenditures as shown by the proposed budget. 
If the estimated expenditures exceed the estimated receipts, 
one of the following courses of action must be taken : 

(a) The departmental expenditures may be reduced. 
In making such reductions a problem arises due to the fact 
that the reduction of expenditures may result in a reduction 
of receipts. For instance, if the expenditures of the adver- 
tising department are reduced, this may result in a reduction 
of sales, with a consequent reduction of receipts from col- 
lections. In the same manner, a reduction of the expendi- 
tures of the production department may result in a reduc- 
tion of production, with a consequent lack of goods to meet 
sales demands which will result in a reduction of receipts 
from sales. Care must be taken, therefore, in the reduc- 
tion of expenditures to see that receipts are not reduced 
more than proportionately. 

(b) Additional receipts may be secured. It may be 
possible by speeding up operations and securing more effi- 
cient administration to secure additional receipts without 
incurring a proportionate increase of expenditures. 

(c) Additional capital may be secured. If it is not 



THE MEANING OF BUDGETARY CONTROL 7 

deemed wise to reduce expenditures, plans must be made 
to secure additional capital with which to finance the excess 
of expenditures over receipts. It is understood, of course, 
that this condition cannot continue for long, otherwise the 
business will find it necessary to liquidate. 

The executive in charge of the budgetary procedure may 
make recommendations with reference to possible pro- 
cedures, but he is usually not invested with authority to 
determine the plans to be followed. 

4. The executive in charge of the budgetary procedure 
prepares from the departmental estimates an estimated 
balance sheet and an estimated statement of profit and 
loss, showing respectively the anticipated financial condi- 
tion at the end of the budget period and the anticipated 
result of the operations of the period. 

5. The departmental estimates, together with the pro- 
posed financial budget, and the estimated financial state- 
ments, are submitted by the executive in charge of the budg- 
etary procedure to a budget committee, composed of the 
principal executives of the company and presided over by 
the president. This committee considers the proposed esti- 
mates and makes such revisions as it thinks necessary. In 
case the proposed budgets involve important changes in the 
company's policy, or require the securing of additional 
capital for a material amount, it may be necessary to submit 
them to the board of directors for consideration. Indeed, 
in some businesses all budgetary plans are submitted to the 
board of directors for approval. After the proposed esti- 
mates have been approved, they constitute the working 
program for the budget period. The budgets as adopted 
set limits upon the expenditures of all the departments, and 
these limits cannot be exceeded without the permission of 
the budget committee. The budgets also set up standards 
of performance for certain departments. For instance, the 



8 BUDGETARY CONTROL 

sales budget states the sales that are to be made by the sales 
department, and the production budget states the estimated 
production of the production department. 

6. Each department makes plans which will enable it to 
carry out its program as outlined by its budget. For in- 
stance, the advertising department makes contracts for 
advertising space; the sales department sets quotas for its 
salesmen; the production department sets up schedules of 
production. 

7. Records are established so that the performance of 
each department may be properly recorded and comparisons 
made between the estimated and the actual performance. 
Periodic reports, showing a comparison between the estimat- 
ed and the actual performance of each department for the 
budget period, are made to the executive in charge of the 
budgetary procedure and are by him transmitted to the 
budget committee and in some cases to the board of direc- 
tors. On the basis of these reports the budget committee 
or board of directors may make such revisions of the budg- 
etary program as it may deem desirable. 

Essential Features 

The foregoing procedure is intended to be suggestive 
only. Each organization must adopt a procedure which is 
fitted to its particular needs. The purpose of the foregoing 
outline is to indicate what budgetary control is by suggest- 
ing how it operates. From this outline it can be seen that 
budgetary control involves the following: 

1. The statement of the plans of all the departments of the business 

for a certain period of time in the form of estimates. 

2. The coordination of these estimates into a well-balanced pro- 

gram for the business as a whole. 

3. The preparation of reports showing a comparison between the 

actual and the estimated performance, and the revision of the 
original plans when these reports show that such a revision is 
necessary. 



THE MEANING OF BUDGETARY CONTROL 9 

Budgetary Control Not a New Idea 

All businesses practice budgetary control to a greater 
or lesser degree although many of them do not realize the 
fact. The newsboy estimates his probable sales before mak- 
ing his purchases, and every business man must do like- 
wise if he is to continue to operate long. Even the farmer, 
who usually scorns the use of formal methods of control, 
estimates the probable returns from land used for various 
kinds of crops and the cost of producing each, and on this 
basis decides upon the crop which he will plant. During 
the war the Red Cross, the Y.M.C.A., and Liberty Loan 
committees used the budgetary idea in their ''drives" by 
setting up quotas for each territory. These quotas were 
based on estiraates of the sales possibilities in these terri- 
tories. Budgets for governmental units have been in use 
for many years, and the "family budget" has long been a 
matter of discussion. 

Many business firms which deny that they operate a 
budgetary program will be found to make and use estimates. 
In this connection the author recalls a visit he made to the 
merchandise manager of a large wholesale store several 
years ago. This executive derided the idea of preparing a 
sales estimate and stated that he did not care to discuss 
such an academic question. A few minutes later the author 
inquired if the merchandise manager permitted his buyers 
to use their own judgment in deciding on the quantity of 
goods to purchase. He emphatically replied that to permit 
the buyers to purchase all they desired would bankrupt the 
firm in six months. In response to the request to explain 
how the buyers' purchases were controlled, he stated that 
the executives of the firm first obtained the average sales 
for the past three years and added to this average the per- 
centage of increase which they expected during the next 
year. After they determined in this manner their ''ex- 



lO BUDGETARY CONTROL 

pected" sales, they "calculated" the purchases necessary to 
meet these sales and instructed the buyers accordingly. It 
took the author some minutes to show the manager that his 
firm was preparing both a sales estimate and a purchases 
estimate. Further investigation showed that it was the 
practice of the treasurer of the company to obtain a copy of 
the sales estimate and purchase estimate and to use these as 
a means of making estimates of cash receipts and disburse- 
ments. In other words, the company had an informal and 
imperfect system of budgetary control. 

Similar investigations will show that all other profitable 
businesses make plans for future operations, and however 
informal these plans may be, they are in essence budgetary 
control. 

Modern Tendency Towards Budgetary Control 

Modern business administration tends more and more 
to become a standardized routine. In a large organization 
such standardization is essential to the maintenance of a uni- 
fied business policy and to the coordination of the activities 
of the several departments ; and coordination means subordi- 
nation to a common head. Business men are gradually 
coming to realize that this can best be accomplished by the 
formulation of plans submitted for approval in black and 
white, if indeed coordination can ever be accomplished in 
any other way for a great length of time. Not that plans 
have not always been made, but they have commonly been 
carried around in someone's head. Becauseof the increase, 
however, in the volume of business performed by the typical 
industrial unit, with the corresponding complexity in busi- 
ness organization, it is coming to be less and less possible to 
maintain a business organization that depends upon the 
intuitive faculties of a single individual developed by years 
of experience, faculties which perish with the individual. 



THE MEANING OF BUDGETARY CONTROL II 

The organization must be independent of any single indi- 
vidual in it. All of which goes to show that there should be 
some systematic method of gathering information from the 
past and formulating on this basis plans for the future, and 
of subsequently reporting how these plans have been carried 
out. Such an accounting and statistical organization we 
may call a budget system. 



CHAPTER II 
THE NEED FOR BUDGETARY CONTROL 

Why Budgetary Control Is Needed 

In the preceding chapter it has been explained that 
budgetary control has long been practiced in an informal 
way but that only in recent years has it been introduced as 
a formal and comprehensive procedure. In fact the firms 
are largely in the minority which have formally adopted 
budgetary control at the present time. It is the belief of 
the author that the delay of business firms to adopt budg- 
etary control as a definite part of their administrative 
methods is due to one of two causes : Either they do not 
fully realize its need, or they do not understand how to 
install and operate it. 

It is the purpose of the present chapter to explain its 
need as an instrument of administration, while the remain- 
ing chapters of this book are devoted to an explanation of 
its installation and operation. 

Budgetary control is urgently needed in administrative 
control for two purposes: 

1 . As a means of coordinating the activities of the various functional 

departments. 

2. As a basis for centralized executive control. 

Perhaps its use for these purposes can best be shown by 
sketching the method by which administrative control is 
exercised in the modern type of business organization, the 
problems which arise therefrom, and the need for a compre- 
hensive method of planning ahead as a basis for solving these 
problems. Much that is said in the remainder of this chap- 
ter, though perhaps more or less familiar to the reader, is 

12 



THE NEED FOR BUDGETARY CONTROL I3 

stated here in order to present a comprehensive picture of 
the problems which give rise to a need of budgetary control. 

Interdependence of Business Activities 

It is the author's experience that executives often be- 
come so engrossed with what they regard as the larger 
administrative policies of their business, that they fail to 
give sufficient attention to many of the administrative 
problems to realize their significance. They are easily Im- 
pressed with the value of a sales campaign which will result 
in a large Increase In the volume of sales, but they may fail 
to realize the importance of working out methods by which 
to coordinate the sales campaign with the production pro- 
gram so that the goods sold will be ready for delivery at the 
proper time. They are keenly Interested in the enlargement 
of manufacturing facilities and the increase of production, 
but may fail to realize the significance of maintaining a care- 
ful check on inventory to avoid the accumulation of unsal- 
able merchandise. 

It is worth while for the executive to make a comprehen- 
sive survey of the whole problem of administrative control 
from time to time to see that he Is not overemphasizing 
some phases of the problem at the expense of others. If 
this chapter serves to Impress upon the reader the inter- 
dependence of all the activities of a business, it will have 
served a useful purpose regardless of his reaction to the 
argument presented in behalf of the need for budgetary con- 
trol as a means of coordinating these activities. 

Functional Activities — ^Their Coordination 

The operations of businesses vary widely and the varia- 
tions in operations produce a divergence In organization, but 
in every business there are certain functional groups of activi- 
ties which must be performed. These functions are: 



14 BUDGETARY CONTROL 

1 . The sales function 

2. The production or purchasing function 

3. The personnel function 

4. The finance function 

5. The standard and record function 

Since these functions are found combined in a single business 
unit, it is fair to suppose that there must be a close relation- 
ship between them. A very brief study will show that there 
is such a close interrelation that it is impossible to perform 
one of them unless the others are also being properly per- 
formed. It is true that some businesses emphasize one of 
these functions and other businesses emphasize another, 
but in no business can any of these functions be safely 
neglected. A few illustrations of the interrelationship will 
make this clear. 

Balancing Production and Sales 

Goods are purchased or produced in order to be sold. 
It is unwise and unprofitable to purchase or produce more 
goods than can be sold within a reasonable time after their 
purchase or production. To do so results in tying up capi- 
tal in a non-income producing investment, for excess inven- 
tories yield no profit. A second danger arising from this 
procedure is the deterioration which may take place in the 
surplus stock due to time or obsolescence. It is obvious, 
therefore, that wise administration will take into considera- 
tion sales expectancies in planning purchases or production. 
The failure to limit purchases and production to correspond 
with sales possibilities has caused many firms heavy losses 
during recent years. 

On the other hand, it is unwise to sell goods in excess of 
the possibilities of supply. To sell more than can be pur- 
chased or produced leads to an unnecessary expense both in 
securing the sale and in handling the inevitable complaints 



THE NEED FOR BUDGETARY CONTROL 1 5 

which arise from failure to fill orders. An additional loss 
may arise from the ill-will of the disappointed customer. It 
is better to refuse an order in the beginning than to accept j^' 
the order and fail to satisfy it. Many firms lost prestige by 
such actions during the years 1 9 1 8 and 1 9 1 9. It is necessary, ^ 
therefore, to consider production or purchasing possibilities 
in planning the sales campaign. In other words, the sales 
function and the production v^r purchasing function are so 
closely interrelated and interdependent that they must be 
considered jointly in planning executive policies. 

Planning for Equipment and Personnel 

Not only must sales and production be correlated, but 
this correlation must be planned sufficiently in advance of 
the time when it is to be effected to make possible the secur- 
ing of the necessary equipment and personnel to produce 
the goods required. In a manufacturing business plant and 
equipment are essential to the production of goods, and in 
considering increased production the possible increase in 
plant and equipment requirements resulting thereform must 
be taken into account. But the quantity of production is 
determined by the volume of sales; so in the end the sales 
campaign determines the plant and equipment program. 
The relation between these two functions can be easily seen. 
Loss will result from the sale of more goods than the present 
equipment can produce or than it is possible or profitable to 
purchase equipment to produce. In this connection three 
questions must be asked : 

1. Can the desired amount of goods be produced with the present 

plant and equipment? 

2. If not, can additional plant and equipment be secured in time to 

produce goods to supply the present demand? 

3. If so, can such plant and equipment be secured and operated 

profitably? 



1 6 BUDGETARY CONTROL 

It is equally unwise to secure plant and equipment beyond 
that needed to satisfy the present or the anticipated demands 
of customers. Consequently the plant and equipment pro- 
gram is closely related to both the sales and production 
programs. 

But equipment cannot be operated without workers and 
it is necessary to know the production requirements suffi- 
ciently in advance of the time of their fulfilment to make 
possible the securing of the necessary amount of personnel. 
Where skilled labor is employed the securing of the proper 
personnel is a problem of major importance. 

Planning of Finances 

The making of sales, the producing of goods, and the 
securing of equipment and personnel, all involve an expend- 
iture of funds. All these operations must be financed and 
they can be carried on only to the extent to which the finan- 
cial resources of the business will permit. It is unwise 
indeed for, a business to plan a sales campaign with the con- 
sequent production requirements without considering the 
financial possibilities of the business. A lack of coordination 
of the sales and production programs may lead to loss, but a 
lack of coordination of the various departmental programs 
of the business with its financial program will lead to bank- 
ruptcy. 

Coordination — Special Problems 

The foregoing illustrations point out the interrelation- 
ship of the primary functions of the business and show the 
necessity for their correlation. But in the securing of this 
correlation many things must be considered. For instance, 
emphasis has been placed upon the desirability of not pro- 
ducing beyond sales requirements because of the consequent 
loss arising from the capital invested and the possible de- 



THE NEED FOR BUDGETARY CONTROL 1 7 

terioratlon of the goods. There may be other factors, how- 
ever, which make it desirable to produce beyond sales ca- 
pacity for a certain period of time. For instance, if the sales 
fluctuate from period to period, it may not be desirable to 
have the production fluctuate accordingly. There are sev- 
eral reasons for this, one of the principal being the problem 
of maintaining a proper labor supply if wide fluctuations in 
production take place. If production fluctuates it is neces- 
sary to discharge laborers whom it may be difficult to replace 
later, especially in the case of skilled labor, or it is necessary 
to retain laborers not employed for full time, which is unde- 
sirable and uneconomical. It may be preferable to main- 
tain a uniform production and thereby accumulate in a 
period of slack sales an inventory which may be used to 
meet the excess demands during the rush period. The loss 
of the excess capital tied up in the inventory may be less 
than the loss which would result from fluctuating produc- 
tion. This is but one illustration of the many problems 
which arise in planning coordination of the operations of 
the functional departments. Many more will undoubtedly 
occur to the reader. 

Cooperation among Functional Officers 

From the few illustrations given, the interrelation of the 
various functions of the business should be evident and the 
necessity for the coordination of these functions should be 
apparent. But business administration can be discussed 
only in terms of business organization, and ''functions" of 
the business can be discussed only in terms of the "function- 
aries " who are responsible for them. The discussion of the 
coordination of functions, therefore, resolves itself into a 
discussion of the coordination of functionaries, and a brief 
study of the prevailing conditions in large business estab- 
lishments will show that such coordination is the most 



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1 8 BUDGETARY CONTROL 

urgent need for effective business organization at the present 
time. A conservative estimate would attribute a majority 
of the business failures of the present time to a lack of co- 
ordination of the functions of the business due to a lack of 
cooperation on the part of the functional officers. That this 
lack of cooperation is not intentional and is due primarily to 
a lack of information which would make such cooperation 
possible, does not change the situation. 

Reason for Present Lack of Coordination 

It is quite easy to see how the present situation came 
about. When the business enterprise was small, with a 
simple organization and its activities local, the owner, who 
was also the manager, was able to exercise direct control of 
all the functions of the business. He acted as the executive 
head of each of the functional departments; he was sales 
manager, production manager, treasurer, and controller, 
all in one. Because of this condition he was able to bring 
about the proper correlation without difficulty. In his ca- 
pacity of sales manager he knew the sales which he estimated 
possible, so that he knew what purchases to make when he 
was acting as merchandise manager or purchasing agent. 
As treasurer he knew the funds which were available so that 
he could make his sales and purchasing plans accordingly. 

When the business unit increased in size and its organiza- 
tion became more complex, the executive was forced to 
delegate certain of his duties to assistants, and the present 
plan of functional organization developed, with a separate 
executive in charge of each function. The change in condi- 
tions is apparent. The sales manager devotes his entire 
time, thought, and energy to the securing of sales, and he 
has no direct contact with the production department. The 
production manager has become engrossed in the problems 
of production and has little or no means of becoming 



THE NEED FOR BUDGETARY CONTROL I9 

familiar with the operations of the sales department. The 
treasurer secures the needed funds as best he can and has 
little information upon which to make his plans. And thus 
the coordination which formerly was brought about by the 
centralization of control in the hands of the chief executive 
is lacking. 

Mere Study of Past Records Inadequate 

During the past few years the functional staff officers of 
many large businesses have realized the necessity for a co- 
ordination of the activities of the various departments of a 
business and have attempted to bring about this coordina- 
tion by studying past results and trying to correct the worst 
evils which were revealed. For instance, the production 
manager may find that on certain articles large inventories 
have been carried, so that he plans to cut down the produc- 
tion of these articles during the coming year, thereby reduc- 
ing the inventories. The treasurer may find that during 
certain months his bank balances are very low because of 
the demand on the part of the purchasing or production de- 
partment for funds, consequently he may plan to increase 
his bank loans at that time during the coming year. In the 
same manner each department may study its past activities 
and plan to correct the difficulties of the past. In some 
cases the departmental heads may go farther and study the 
past operations of the other departments so as to see the 
cause for the difficulties Incurred in their own department. 

This method of attacking the problem accomplishes 
some results; but even if carried out very completely it 
usually is subject to two serious objections: 

I. It is basing future plans on past results and not taking into con- 
sideration possible changes. This is almost sure to lead to 
inaccuracies, since a business does not remain stationary; it 
either advances or goes backward. 



20 BUDGETARY CONTROL 

2. It is a negative rather than a positive program. It plans to try to 
remove the difficulties of last year ; its goal is to try to do this 
year what it should have done last year. It is only an attempt 
to reach a past goal, not an attempt to reach a new goal which 
should have been set for this year. 

New Method Needed 

It is contended, therefore, that a new method and a new 
policy is needed, different from that followed by many firms 
at present, a policy which will provide correlation and com- 
pel progress. Such a policy will involve dealing with future 
plans rather than with past results, although plans must of 
necessity be formed in the light of results. Administrative 
control necessitates the use of estimates. The past is gone 
and cannot be changed. It is only future operations over 
which control can be exercised. 

If the departmental estimates are to be used efficiently 
and effectively, it is necessary that a procedure be developed 
for their preparation, coordination, and operation. This 
procedure when established constitutes budgetary control. 

Centralization of Executive Control 

If efficient administration is to be accomplished, it is 
necessary to provide not only for the making of plans to 
secure coordination of departmental activities, but also for 
administrative control of these activities so that the plans 
made will be carried out. The tendency in business admin- 
istration during the past half century has been towards 
centralization of control in the hands of a few executives and 
the delegation of duties by these to subordinates who are 
responsible to the primary executives for the performance 
of the tasks thus delegated. This method has important 
advantages, but it also gives rise to certain significant prob- 
lems. In order to see the nature of these problems and the 
need of budgetary control in their solution, let us sketch 



THE NEED FOR BUDGETARY CONTROL 



21 



briefly the method of exercising administrative control in a 
typical organization. 

Although the tendency during the past several years 
has been towards the centralization of administrative con- 
trol, the number of people who exercise influence in the 
administration of the typical business is quite large. The 
ultimate control of a business is with the owners, but in the 
modern corporate enterprise their control in the main is 
exercised only indirectly. Most of their authority is dele- 
gated to a board of directors, who in turn delegate a large 
part of their authority to the general officers of the corpora- 
tion. The general officers in turn entrust the execution of 



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Figure i. Chart Showing Corporate Form of Organization 

many of the policies of the business to subordinates, and 
these subordinates employ the services of assistants who 
are directly in contact with the workers. Such a form of 
organization may be shown graphically as in Figure i . 

From the foregoing graph it can be seen that in the cor- 
porate enterprise executive control is exercised through the 
medium of a number of groups, cooperating in the perform- 
ance of the administrative function. As showing the prob- 
lems involved in securing this cooperation, a brief account is 
given below of the degree of control exercised by each group. 

Control Exercised by Owners 

In the corporate type of business organization the own- 
ership is vested in the stockholders. Legally the executive 



22 BUDGETARY CONTROL 

control also is vested in the stockholders. As a matter of 
practice they exercise this control very indirectly. The 
stockholders pass upon only a few of the policies of the busi- 
ness, the remainder being left to the jurisdiction of the board 
of directors which is chosen by the stockholders. The direct 
control of the stockholders is usually limited to the follow- 
ing: 

1. Protection of Property Interest. The stock- 
holder invests in the corporation for two purposes: (a) to 
secure the preservation of his capital, and (b) to secure an 
income from the use of the capital in the business. He de- 
sires reports which will show that his property interest is 
being protected, and in case he realizes that it is being im- 
paired, he may exercise his right to direct actively the opera- 
tions of the business. Of course, such action is possible 
only where there is a community of interest with conse- 
quent cooperation of a majority of the stockholders. 

2. Maintenance of Dividend Rate. As stated in the 
preceding paragraph, the stockholder desires to obtain an 
income from the use of his property in the operation of the 
business. This income he obtains by means of the dividends 
which are declared by the board of directors. He desires 
consequently that the dividend rate be sufficiently high to 
afford him a proper return on his investment, and he desires 
that this dividend rate be maintained regularly if possible. 
He is especially sensitive to a lowering of the dividend rate 
or the passing of a dividend pa3anent. He desires, there- 
fore, to be consulted about a change of policies which will 
affect the dividend rate. The chief interest of most stock- 
holders in the board of directors is in the question of its 
ability to protect their property interests and to maintain a 
fair and adequate rate of dividend. So long as this is accom- 
plished, the stockholder does not seek to interfere in the 
administration of the corporation. 



THE NEED FOR BUDGETARY CONTROL 23 

3. Financing of Extensions. If extensions are to be 
made on a large scale, it may be necessary to appeal to the 
stockholders to contribute additional capital or to obtain 
their permission for the issuance of additional stock or bonds. 
In either case the consent of the stockholders should be 
obtained by the board of directors, although in the case of 
issuing bonds the stockholders' approval is often only formal, 
since the board of directors works out the plan and submits 
it for approval. It is within the province of the stockholders 
to reject such plan, but this authority is exercised rarely. 

Control by Board of Directors 

The preceding discussion has emphasized the fact that 
the stockholders delegate most of their powers of control to 
the board of directors. The board of directors, although 
they are responsible for the administration of the business, 
do not as directors participate in such administration. They 
content themselves with outlining the general policies to be 
followed and then delegate the execution of these policies to 
the general officers of the business. The method by which 
the board of directors exercises control may be indicated by 
the following: 

I, They select the general officers of the company and delegate to 
them certain administrative duties. 

2» They outline the general policies of the business for the guidance 
, of these executives, to the end that the desires of the stock- 
holders may be realized; that is, that their property interests 
be protected and a reasonable dividend rate maintained. To 
this end they may set up a dividend rate which is to be main- 
tained, and judge the efficiency of the general officers by their 
ability to make possible the maintenance of this rate. 

3. They consider and approve, modify, or reject the general plans 
submitted by the general officers. Such plans include the 
estimates or budgets which the general officers present to show 
their proposed accomplishment during the coming period. 



24 BUDGETARY CONTROL 

4. They receive reports from the executives of the business which 

show the degree of success they have attained in carrying out 
the plans which have previously been approved. Such reports, 
if properly prepared, show the success of each principal execu- 
tive, as well as the success which has attended the efforts of 
the executive staff as a whole. 

5. They award bonuses or increases of salaries to the executives on 

the basis of their performance, and thus encourage efficiency 
and initiative. 

Such are the duties of the board of directors in most 
cases. In a corporation where the general ofhcers of the 
corporation are members of the board, they may exercise a 
more direct control than that indicated. It is questionable, 
however, whether in this case the general officers are not 
acting in their capacity as executives rather than as direc- 
tors. It is not feasible or desirable to consider here in detail 
the administrative functions of the board of directors. It 
is sufficient for our purposes to see that the execution of the 
administrative policies of the business is left in the main to 
the general officers of the business. 

Control through General Officers 

As indicated by Figure i , it is customary to have in each 
business a chief executive who is responsible for the admin- 
istration of the business. In a corporation this executive is 
usually the president, although in some cases the president 
may be subordinate to the chairman of the board of direc- 
tors, when the latter assumes active executive duties. For 
the purposes of this discussion we will assume that the presi- 
dent is the chief executive officer. 

In a small business the president may supervise and 
direct all of the administrative functions. In a business of 
any considerable size this is impossible and it is necessary 
to employ other officers to assist in the formulation and 
execution of the executive policies of the business. The 



THE NEED FOR BUDGETARY CONTROL 25 

number of such officers who may be employed and the duties 
which they may perform will depend to a considerable ex- 
tent on the nature of the operations of the business and 
consequently on the administrative functions which must 
be subject to executive supervision. On a previous page 
it has been explained that the primary administrative func- 
tions are: 

1. The sales function 

2. The production function 
.3. The purchasing function 

4. The personnel function 

5. The finance function 

6. The standard and record function 

In a business of sufficient size to make advisable a func- 
tional organization of the administrative personnel, there is 
an executive head for each of the foregoing functions and 
therefore we have the following general officers : 

1. Sales manager 

2. Production manager 

3. Purchasing manager (often termed purchasing agent) 

4. Personnel manager 

5. Financial manager (usually termed the treasurer) 

6. Standard and record manager (usually termed the controller) 

The foregoing list of functional managers w^ho assist the 
president or the general manager in the formulation and 
execution of the policies of a business is intended to be sug- 
gestive rather than inclusive. The ones mentioned are those 
which are needed to supervise and control the functions 
common to all businesses. 

Control Exercised by Junior Executives 

As indicated by Figure i , the general officers delegate a 
considerable part of their administrative duties to the sub- 
ordinate or junior executives. No definite statement can 



26 BUDGETARY CONTROL 

be made with reference to the duties to be performed by 
these officers, but the modern tendency is to delegate as 
many details as possible so that the general officers may 
have more time to give to a consideration of general plans 
and policies. The junior officers delegate duties to their 
assistants, and these in turn give instructions to the workers, 
both manual and clerical. 

Result of the Delegation of Administrative Duties 

The foregoing sketchy outline of the process by which 
administrative control is exercised in the typical business 
organization shows that it involves a continual delegation of 
duties from one administrative group to another. The 
stockholders delegate duties to directors, the directors dele- 
gate duties to the general officers, the general officers dele- 
gate duties to subordinate officers, and so on. Experience 
has shown that in such an organization, if rational control is 
to be exercised, it is essential that there be available informa- 
tion of three kinds : 

1. Information which will serve as a basis for the formulation of the 

general policies of the business and for the delegation by each 
group of certain duties to the next subordinate group. 

2. Information which will enable each group to perform properly 

the duties delegated to it and to coordinate its activities with 
those of all the other groups. 

3. Information which will enable each group to judge as to the effi- 

ciency with which the duties delegated by it have been per- 
formed by the subordinate group to which they were delegated. 

To obtain this information in an accurate and compre- 
hensive manner it is necessary 

1 . To maintain accounting and statistical records which will show 

past performance. 

2. To use the information shown by the accounting and statistical 

records as a basis for preparing estimates of future per- 
formance. 



THE NEED FOR BUDGETARY CONTROL 27 

3. To obtain from the accounting and statistical records the current 

performance. 

4. To prepare reports showing a comparison between current, past, 

and estimated performance. 

Judging by Past Performance and by Contemplated Plans 

In the past, executives have relied primarily on informa- 
tion with reference to current and past performance. They 
have judged current results by past results. They have 
left their subordinates to use their initiative to a large extent 
and rewarded them on the basis of the success which they 
attained. To some extent this practice is still followed. 
As pointed out in the discussion of the control exercised by 
the stockholders, they judge the success of the directors by 
their ability to maintain the capital of the corporation and 
to earn a satisfactory income. It is typical of them to con- 
sider the accomplished results of the directors* administra- 
tion rather than the anticipated results of their contemplated 
plans. Many stockholders have followed this custom to 
their sorrow and have found their investment dissipated by 
actions of the directors which they could not correct after 
they had been consummated. In some cases directors 
depend on reports showing the results of the actions of the 
general ofhcers instead of insisting on reports showing their 
contemplated plans and the anticipated results of these 
plans. Officers in turn sometimes follow the same policy in 
dealing with subordinates. 

Gradually, however, stockholders, directors, and general 
officers are coming to realize that effective administration 
requires the making of plans and that the formulation of 
plans necessitates the use of estimates. The preparation 
and enforcement of these estimates is the purpose of the 
budgetary program as outlined in the following chapters. 



CHAPTER III 
PRELIMINARY STEPS IN INSTALLATION 

First Steps Towards Budgetary Control 

Many business firms which reahze the need for budg- 
etary control are at a loss how to proceed to effect its installa- 
tion. Often an attempt is made to commence its operation 
without giving proper thought to the formulation of a com- 
prehensive procedure for its execution. In these cases 
undesirable consequences almost invariably result. In 
working out the budgetary procedure it is necessary that a 
logical sequence be followed so that no part of the program 
may be delayed because of the failure of any other part. 

Executives have a tendency to think that the depart- 
mental estimates are the essence of the budgetary program 
and consequently start the preparation of sales estimates, 
production estimates, and financial estimates without first 
working out a procedure to govern their preparation and 
use. Consequently a great amount of data is collected as 
the result of much labor and expense but is found to be of 
little use because it is not in form to be correlated and also 
because the executives do not understand the service which 
may be obtained from it. They are apt to feel, therefore, 
that the budgetary program entails useless expense and 
they seek to secure its abandonment. 

It is necessary for the success of the budgetary plans that 
certain preliminary problems be settled before the budgetary 
process is commenced. Every professional accountant and 
industrial engineer who has given consideration to methods 
of administrative control has seen many well-intended ad- 
ministrative plans fail because attention had not been given 
to the problems to which they necessarily give rise, or to the 

28 



PRELIMINARY STEPS IN INSTALLATION 29 

method of meeting these problems. This situation is par- 
ticularly apt to occur in an attempt to install budgetary 
control, because most executives have not given careful 
thought to its operation and consequently are not apt to 
foresee the problems to which it will give rise. 

It is the purpose of this chapter to discuss the first steps 
which are involved in the installation and operation of 
budgetary control. The following topics will be discussed 
in order: 

1 . Length of the budget period 

2. Responsibility for the preparation of estimates 

3. ResponsibiUty for reports 

4. Method of enforcing budgets 

5. Cooperation of executives and employees 

Length of the Budget Period 

One of the first questions which arise in connection with 
the installation of budgetary control is, What shall be the 
length of the budget period? Little or nothing can be done 
until this question is answered. Each department must 
know the period for which its estimate is to be made, other- 
wise the various departmental estimates will in all probability 
be for different periods of time and hence cannot be corre- 
lated. For instance, if the sales estimate is made for six 
months and the production estimate for one year, it is not 
possible to compare the two. 

The length of the budget period is governed by a number 
of factors, the most important of which are : 

1 . Length of merchandise turnover period 

2. Length of production period 

3. The method of financing employed 

4. The market conditions 

5. The adequacy and completeness of the data with reference to 

past operations ' 

6. Length of the accounting period 



30 BUDGETARY CONTROL 

Length of Merchandise Turnover Period 

If a business has a long turnover period and the peak of 
the sales comes at the end of the period, it is necessary for 
the budget period to be equal in length to the turnover 
period. Otherwise it is impossible to obtain a correlation be- 
tween sales and purchases or production. Such a condition 
is apt to exist where sales are affected by seasonal demands. 

To illustrate, a publishing company selling textbooks 
for use in secondary schools has the principal volume of its 
sales in July, August, and September, just before the open- 
ing of the academic year. It has a smaller volume in Janu- 
ary prior to the opening of the second semester, and has 
scattering sales throughout the year. In preparing its budg- 
ets it is preferable to make them one year in length but 
subdivided by months, so that the total required operations 
of each department for the year can be seen and these sched- 
uled by months. It is necessary for the company to have 
some books printed throughout the year, otherwise it will 
be impossible to have sufficient inventory on hand to meet 
sales demands during the rush season. Consequently the 
production during any month or quarter will not correspond 
with the sales for that month or quarter. During the 
period of slack sales the production will exceed the sales, 
while during the period of large sales the production will be 
less than the sales. It should be easily seen, therefore, that 
it is impossible to secure a coordination between the sales 
estimates and the production estimates for any period less 
than a year. Assuming that a uniform inventory is main- 
tained, the sales for the year will equal the production for 
the year, but this equality will not exist for any shorter 
period of time. Similarly a proper comprehension of the 
financial requirements of the business can be obtained only 
on the basis of the year's program, although estimates of cash 
receipts and disbursements can be made monthly. 



PRELIMINARY STEPS IN INSTALLATION 31 

In a business having a long turnover period it is usually 
preferable to make the budget period of corresponding 
length. On the other hand, a business like a grocery store 
which has a short turnover period will find it feasible to 
have a short budget period. In such a business sales are 
apt to fluctuate from period to period, and by having a short 
budget period it is possible to take advantage of these fluc- 
tuations in making the budgetary program. If the turnover 
period is short it is usually possible to purchase additional 
goods easily and quickly; therefore it is not difficult to re- 
plenish the inventory even though sales are estimated for 
only a short period of time in advance. 

Length of Production Period 

In a manufacturing business producing a commodity 
which requires a long production period, it may be necessary 
to provide for a budget period which is at least equal in 
length. It is necessary to know the sales a sufficient length 
of time in advance to make possible the placing of orders 
which will result in an inventory of sufficient size to meet 
the sales demands. It is obvious that the orders must be 
placed a length of time equal to the production period in 
advance of the time when the sales are to be made. This is 
particularly essential in a business where the sales fluctuate 
from period to period and there is a corresponding fluctua- 
tion in the production. For instance, the X Company, 
which has a production period of six months, estimates that 
its sales will increase 50 per cent during the last quarter of 
the year 1922. The production department should be in- 
formed of this expected increase by April i , if it is to have 
the inventory available to meet these sales. The reader can 
probably recall numerous other illustrations which will show 
the relation between the length of the production period and 
the budget period. 



32 BUDGETARY CONTROL 

Method of Financing Employed 

In some cases the financial peak load comes at a time of 
the year when it is difficult to obtain the necessary funds 
quickly. Consequently, it is desirable to make financial 
arrangements some time in advance of the period when the 
peak load will come. In such cases it may be necessary to 
make the budget period sufficiently long to make possible 
the determination of financial requirements some months in 
advance. If the executive can go to his banker several 
months before the funds are required and show him the 
contemplated plans of the business with the consequent 
demand for funds at the time of the peak load, he is much 
more apt to get a promise of funds than if he waits until the 
funds are urgently needed. In the latter case the banker 
does not see the reason for the sudden demands for funds, 
while in the first case he has seen months in advance that 
the plans of the business would result in a need for funds at 
that particular time. 

The treasurer of a young but rapidly growing corpora- 
tion in New York City has built up a large line of bank 
credit for his firm by following the practice of taking his 
financial budget to the bankers at the beginning of each 
year and showing them the plans for the year and the 
consequent financial requirements. At the end of the year 
he shows them a comparison between the budgets for the 
year and the actual results. By this means he shows them 
his requirements and convinces them that the credit which 
he requests is reasonable and justified. 

There is a growing tendency among business firms to 
determine their financial requirements for a considerable 
period of time in advance and to arrange for the necessary 
funds prior to the initiation of the program which necessi- 
tates the funds. If provision for the necessary funds cannot 
be made, the program is revised. The advantage of this 



PRELIMINARY STEPS IN INSTALLATION 33 

plan over the far too frequent practice of starting the 
program and arranging for the procurement of funds when 
the necessity for them arises should be apparent to the 
reader. 

Market Conditions 

When the market conditions are uncertain and variable, 
it is desirable to make the budget period as short as possible, 
in order that revisions in plans can be made more easily. 
Estimates are always difficult to make with accuracy and in 
a period of uncertain market conditions this difficulty is 
greatly increased. 

If the sales estimate proves incorrect this will affect all 
the other estimates, since most of them are based, at least 
in part, on the sales estimate. For instance, it was impossi- 
ble for a firm in January, 1921, to estimate accurately its 
sales for the year, and if correct estimates for the year had 
been prepared based on the yearly sales estimates, it would 
have been entirely a matter of accident. Many firms pre- 
pared their estimates for 1921 on a quarterly basis and made 
new estimates at the beginning of each quarter. Even 
these they found necessary to revise monthly. For the 
year 1922 similar difficulties exist. 

The marketing methods of a business may affect the 
length of its budget period. For instance, sorae of the large 
mail-order houses issue catalogues each six months, which 
quote prices effective for that period of time. In order to 
protect themselves they find it necessary to enter into con- 
tracts for the purchase of sufficient goods to satisfy the 
estimated sales demands for the period covered by the cata- 
logue. As a consequence it is necessary for these firms to 
make their budget period six months in length, since their 
sales estimates and purchase estimates must be made for 
this period of time. 



34 BUDGETARY CONTROL 

Adequacy and Completeness of Data 

In a new business, or in an old-established one where 
adequate records have not been kept, it is impossible to 
obtain adequate statistics with reference to past results. 
Hence it is difficult to estimate future operations, for esti- 
mates should always be made in the light of past events. 
In such cases it is better to make the budget period as short 
as possible so that new budgets can be made as statistics 
are obtained which will serve as a basis for their preparation. 

Length of Accounting Period 

After estimates are made, it is necessary that means be 
provided for checking their accuracy. This is usually 
accomplished by preparing reports showing a comparison 
between the estimated and the actual results. The actual 
results are obtained to a considerable extent from the 
accounting records. The information obtained from these 
records is usually obtainable only at the end of an account- 
ing period. It is necessary, therefore, that the budget period 
end on the same day as an accounting period. The budget 
period may include two or more accounting periods, so 
long as it commences on the first day of one period and 
ends on the last day of the same or some other period. 
There is a recent tendency of business firms to secure the 
information with which to check the budgetary program 
from sources other than the accounting records. But even 
in this case, the information so obtained is later checked 
by the accounting records. 

Usual Length of Budget Period 

The usual length of the budget period is for three, six, 
or twelve months. Some firms state their general plans for 
one year in advance so as to have a goal to work for, but 
work out detailed schedules for only one month at a time. 



PRELIMINARY STEPS IN INSTALLATION 35 

A few firms known to the author make their budgets for one 
year, and at the end of each month drop the past month and 
add one month at the other end of the period. By this 
means they have their budgetary plans made for twelve 
months in advance at all times. Regardless of the length 
of time for which the budgets are prepared, they must be 
scheduled to show monthly expectancies, so that compari- 
sons can be made at the end of each month between the 
actual and the estimated performance and the necessary 
revisions put into effect. 

General Conclusions as to Length of Budget Period 

It will undoubtedly occur to the reader of the foregoing 
discussion that some of the factors, which it is suggested 
must be considered in determining the length of the budget 
period, afford an argument for a short period while others 
afford an argument for a long period. This is undoubtedly 
correct and it is the purpose of the discussion to emphasize 
this fact. It is desired to suggest to the reader that an 
arbitrary answer cannot be given to the question. How long 
shall the budget period be? In each business all the factors 
suggested should be consideted and the length of the budget 
period determined as a result of this consideration. 

In conclusion it may be said that it is important that 
two things be accomplished by the budgetary program : 

1. That the executives obtain a perspective of the plans of the busi- 

ness for a sufficient length of time in advance to enable them 
to adjust their plans to the general program without too much 
abruptness. This is especially important in a rapidly grow- 
ing business or one subject to material changes. 

2, That the executives have a definite and concrete program for the 

immediate future which they can use as the basis of day-to-day 
operations. Such a program is also necessary as a basis for 
comparing the actual with the estimated performance, and 
unless this comparison is made it is impossible to exercise an 



36 BUDGETARY CONTROL 

effective control of the budgetary program. Such a definite 
and concrete program can usually be made for only a short 
time in advance. 

For these reasons, therefore, it is desirable to make at 
least a general program for one year in advance and to make 
subsidiary thereto a more specific program for a month or a 
quarter. The latter program can be used as the basis for 
immediate action, while the former can be used as the basis 
for future planning. The yearly program can be revised 
monthly or quarterly as the changing conditions demand. 
In working out some of the programs of the business — for 
instance, the advertising program — it may be necessary to 
make general plans for two or three years in advance. 

Responsibility for Preparation of Estimates 

At the very inception of the budgetary program it is 
necessary to determine the responsibility for the preparation 
of the various estimates which its installation requires. The 
practice of business firms in this matter varies widely. In 
some businesses the controller and his staff prepare the esti- 
mates and submit them to the departmental executives for 
revision or approval. This method may secure satisfactory 
results if the controller has a well-trained staff and if the 
fluctuations in the volume of business are small. 

It is the opinion of the author that though the controller 
and his staff may be able to prepare accurate estimates, it 
is not desirable for this task to be performed by them. One 
of the important results of budgetary control is the benefit 
derived by the executives in its installation and operation. 
If the major part of the work is performed by a central 
agency such as the controller, those who should benefit most 
from the budgetary program lose the opportunity of gaining 
this advantage. 

In most businesses the departmental executives are held 



PRELIMINARY STEPS IN INSTALLATION 37 

responsible for the preparation of the estimates. The sales 
manager is held responsible for the sales estimate, the pro- 
duction manager is held responsible for the production 
estimates, and so on. Each departmental head will usually 
delegate his responsibility for the preparation of the esti- 
mate of his department to subordinates. Practice varies 
greatly with reference to the subordinates selected for this 
task. If the head of the department has a staff, he may ask 
his staff assistants to perform the task. For instance, the 
sales manager may have the sales estimate prepared in his 
office by staff assistants, and the production manager may 
do likewise. 

On the other hand, the sales manager may ask his branch 
and division managers to prepare estimates of their sales, 
and he may then combine these to get the total estimated 
sales. In this case the sales manager and his assistants will 
study the estimates submitted by the subordinates and 
make revisions where necessary. The production manager 
may ask his works managers to submit estimates, and these 
in turn may ask the advice of their foremen or heads of de- 
partments. The production manager and his assistants 
will make such revisions as the evidence they have at hand 
indicates to be necessary. 

Responsibility for Performance Best Source of Estimates 

It is the experience of the author that as a general rule 
better results will be obtained if the individuals responsible 
for the performance of the estimate are the ones who origi- 
nate it. This procedure is desirable : 

1. Because these individuals should be best able to make the esti- 

mate. 

2. Because they will obtain the most value from making it. 

3. Because if they are required to make the estimate, they will feel 

more responsible for its enforcement. 



38 BUDGETARY CONTROL 

To illustrate the foregoing by means of the sales estimate, 
the branch manager should know more about the sales possi- 
bilities in his territory than does the sales manager. If he 
does not, he ought to be made to study his territory until he 
does. If he is required to make the sales estimate, either 
he will make it more accurately than will the sales manager, 
or the latter can discover the incapacity of the branch man- 
ager and take the necessary steps to correct the situation. 
In making the sales estimate the branch manager will learn 
much, because its preparation will force him to study past 
results and future prospects. Finally, if the branch mana- 
ger makes the original estimate he will feel more responsi- 
bility for its enforcement than if it is prepared by the general 
office without consultation with him. If he fails to meet an 
estimate to which he has previously agreed, he cannot object 
to being required to explain the reasons for his failure. It is 
of course possible to enforce procedures whether subordi- 
nates like them or not, but this is rather destructive of 
morale, and morale is an important factor in present-day 
administration. 

What has been said in the foregoing paragraph with ref- 
erence to the sales estimate is equally true with reference to 
all the other estimates. Better results will be obtained if 
the line subordinates are consulted in their preparation. 

Responsibility for Reports 

After the budgetary program is established, it is neces- 
sary to have periodic reports showing the performance of 
each department so that a comparison may be made between 
the estimated and the actual performance. To accomplish 
this it is necessary that two things be done : 

1. That the reports desired be determined. 

2. That the responsibility be fixed for the preparation of these 

reports. 



PRELIMINARY STEPS IN INSTALLATION 39 

Because of the importance of the reports used in budget- 
ary control, it is desirable that considerable attention be 
given to their form and content. It is preferable that they 
be designed by a central authority so that the information 
received from all departments will be in proper form for 
comparison and correlation. The executive in charge of the 
budget procedure knows the form in which the information 
is desired for his use and for the use of the budget committee, 
hence he is best able to design the necessary reports. 

It is advisable that the reports desired be determined at 
the beginning of the budget period so that provision can be 
made for collecting the information needed for their prepa- 
ration. If instructions for their preparation are not issued 
until the end of the period, it is very possible that some of 
the necessary information will not be available. This not 
only results in a failure to secure the desired information, 
but also tends to create ill-will on the part of those who are 
held responsible for the preparation of the reports. 

The departmental heads are responsible for the prepara- 
tion of the departmental estimates, but in many cases it is 
not possible to make them responsible for the preparation 
of the reports showing the actual performance. In some 
cases it is more desirable to obtain this information from the 
accounting department or a central statistical department. 

In any case, it is necessary to determine from which de- 
partment this information should come and fix responsibility 
therefor, and this determination should be reached very 
early in the course of the budgetary procedure in order 
that plans may be made by the department made respon- 
sible for the collection of the required data. 

Necessity for Promptness in Preparing Reports 

In deciding the responsibility for the preparation of re- 
ports, careful attention should be given to the necessity for 



40 BUDGETARY CONTROL 

their prompt preparation after the end of the budget period. 
Unless they are prepared with promptness so that the actual 
and the estimated performance can be compared imme- 
diately after the close of the period, it is impossible to make 
the necessary revisions in the budgetary program which the 
reports show are necessary. To know the variations be- 
tween the estimated sales and the actual sales of January is 
of value if the knowledge is available on February i, but 
such knowledge is of little value in controlling the budget 
program for February if not available until February 25. 

It will seem on first thought that it is the function of the 
accounting department to prepare the budget reports. 
There are certain advantages in this procedure since it elimi- 
nates the possibility of duplication of work if another depart- 
ment is required to collect and report data which will later 
be shown in the accounting records. The reports are also 
apt to be more accurate if they are verified by the formal 
methods employed by the accounting department. It has 
been the author's experience, however, that it is difficult to 
get the accounting department of most businesses to sum- 
marize their records at the end of the period with sufficient 
speed to make available the desired reports at the time 
needed. He has found it advisable, therefore, to obtain in- 
formation regarding actual performance from other sources 
wherever possible. It is true that the audited reports pre- 
pared from the accounting records may differ slightly from 
those prepared by the operating departments, but these 
differences are usually not of sufficient amount to affect the 
conclusions to be drawn from the latter. 

Method of Enforcing Budgets 

After the departmental estimates have been approved 
it is necessary for each department to formulate plans to 
carry out its estimate. Unless this is done the budgetary 



PRELIMINARY STEPS IN INSTALLATION 4 1 

program is apt to result in failure. Many firms have made 
estimates of departmental activities but have failed to formu- 
late a plan for their attainment, with the result that the ^ 
actual has varied widely from the estimated performance 
and consequently the executives have tended to feel that 
the budgets had little or no significance. A well thought- 
out plan for the enforcement of the departmental estimates 
should be formulated before the introduction of the budg- 
etary program. 

The method by which the departmental estimates will 
be enforced will vary with the different departments. For 
instance, the sales department may find it necessary to set 
up quotas for the different sales units and for salesmen at 
each unit in order to secure the amount of sales called for by 
its estimate. The production department will find it neces- 
sary to set up balance of stores records so that the inventory 
schedules called for by the production budget may be main- 
tained, and to operate a planning department so that its 
schedule of finished goods may be enforced. Other depart- 
ments will find it necessary to use similar means to carry out 
their programs. 

Some part of this procedure may be developed as the 
budgetary program proceeds, but it is necessary to remem- 
ber that it is useless to set up a budgetary program unless 
means for its enforcement are provided, and it is necessary 
that the means be developed as early as possible in the 
installation of the budgetary procedure. 

Cooperation of Executives and Employees 

In order that the budgetary program be properly formu- 
lated and executed it is necessary that all the executives 
and employees of the business cooperate to that end ; and in 
order to secure their cooperation it is necessary that they be 
instructed with reference to the budgetary plans so they 



42 BUDGETARY CONTROL 

may understand the relation of the duties delegated to them 
to the general plans of the business. Although previous to 
its installation it is impossible to secure a complete realiza- 
tion by all the executives and employees of what the budget- 
ary program involves, as much as possible should be done 
to this end before the budget program commences. If di- 
plomacy and tact are used much can be accomplished. 

After the budgetary program is installed, it is desirable 
to have prepared a manual on budgetary procedure outlining 
the purpose of the budget program and the procedure to be 
followed by all departments and units of the business in its 
preparation. If this manual is placed in the hands of all 
those responsible for the performance of duties in connection 
with the budget program, it will aid them to see the necessity 
and desirability for prompt and efficient cooperation on 
their part. The contents of such a manual is discussed and 
illustrated in Chapter XXIII. 

Much more might be said with reference to the impor- 
tance of securing the cooperation of executives and em- 
ployees, but it is thought that the necessity for this coopera- 
tion is evident. The method which should be employed to 
secure their cooperation will depend on the circumstances 
of each case. Tact, courtesy, and patience are all neces- 
sary, and these should be backed up by determination based 
on confidence in the program and comprehensive knowledge 
of the method of executing it. 



CHAPTER IV 
ORGANIZATION FOR BUDGETARY CONTROL 

Need for Organization 

The preceding chapters have shown that in the operation 
of budgetary control it is necessary to formulate a com- 
prehensive procedure which will govern the preparation, 
correlation, and enforcement of the departmental estimates. 
To insure the carrying out of the budgetary procedure, 
it is necessary to set up an organization responsible for 
its enforcement; and it is desirable that this organiza- 
tion be effected before the budgetary program is initiated, 
for otherwise there will be no fixed responsibility for its 
enforcement, and delays and errors are almost sure to occur. 
These errors and delays tend to lessen the interest and en- 
thusiasm of the executives and employees in the budgetary 
program, and this in turn renders its successful completion 
more difficult. It is the purpose of this chapter to indicate 
the nature of the organization which many business firms 
have found desirable. 

Head of the Budgetary Program 

Previous chapters have em.phasized the interrelation of 
the activities of the functional departments and the need 
of a correlation of these activities. Since it is the purpose of 
budgetary control to effect this correlation, the budgetary 
program is as broad and comprehensive as the business 
itself. Inasmuch as the budgetary program involves the 
activities of all the departments, it is not expedient to dele- 
gate its execution to any one department. Rather, it is 
necessary to set up an organization which, although it must 

43 



44 BUDGETARY CONTROL 

include the executives of all departments, has a central 
head which is independent and superior to the departmental 
executives. 

In harmony with this conclusion, it is desirable that the 
president or chief executive of the business should have 
direct control of all matters pertaining to the budgetary 
program. He must of necessity delegate most of the duties 
imposed on him by this program to subordinate officers, but 
these officers should act as his agents and be directly re- 
sponsible to him for the proper performance of the duties 
delegated to them. In case of disagreement between de- 
partments with reference to the coordination of estimates, 
the decision of the president must be final. 

Disadvantages of Not Having Chief Executive at Head 

The importance of having the chief executive in direct 
and immediate control of the budgetary program cannot be 
overemphasized, for unless this be done two undesirable 
situations may develop : 

1. The departmental executives and their subordinates 
will fail to realize the importance of the budgetary work and 
will not give it the time and attention necessary to make it 
worth while. If they are required to submit estimates and 
to make reports regarding their execution to some subordi- 
nate official, or even to the head of some other functional 
department, such as the general auditor's, they are apt to 
resent what they will regard as an undue interference with 
their activities by one who is not directly concerned with 
them. 

2. Disagreements will arise with reference to the co- 
ordination of departmental programs. For instance, the 
sales department may desire to sell more than the produc- 
tion department thinks it can produce profitably, or the 
production department may desire to produce articles which 



ORGANIZATION FOR BUDGETARY CONTROL 45 

the sales department does not think it can sell, or both the 
sales and production departments may desire to increase 
their activities beyond what the financial department thinks 
can be financed. Obviously the only authority who can 
decide these questions is the chief executive who is superior 
to all the executives interested in the controversy. These 
departmental executives will not accept as final the decision 
of an officer of equal or lower rank to themselves. Further- 
more, if the executives in charge of the preliminary work on 
the budget are the direct representatives of the chief execu- 
tive they are apt to be given more consideration than if they 
are members of a subordinate department. 

Direct Control of Governmental Budgets by Chief Executive 

In the' preparation of governmental budgets it has usually 
been assumed that final control and responsibility is vested 
in the chief executive. Consequently he is usually required 
to submit to the legislative body the proposed budget with 
his personal approval, and he is held directly accountable 
for its contents. In the enactment of the recent legislation 
creating budgetary control for the United States govern- 
ment, there was much discussion with reference to the rela- 
tion of the President to the budgetary organization. The 
Senate desired to place the Budget Bureau in the Treasury 
Department, while the House desired to make it independ- 
ent of any department and answerable directly to the 
President. The New York Evening Post discussing the 
proposed law very ably sets forth the arguments for placing 
the President in direct control of the Budget Bureau, in the 
following editorial entitled "Th^ Right Kind of Budget": 

Passage by the Senate of the McCormick budget bill is gratify- 
ing as a forecast of the early establishment of a budget system at 
Washington. But it is highly desirable that we get the right kind of 
budget system. Otherwise the work will have to be done over. 



46 BUDGETARY CONTROL 

One of the prime essentials of a proper budget is that it be placed 
directly under the President. The McCormick bill places the system 
in the Treasury Department. On the other hand, the Good bill, 
which has been introduced in the House, places the Budget Bureau 
directly under the President. This undoubtedly is the course that 
should be followed. The McCormick arrangement, if not fatal to 
the right function of a budget system, would greatly hamper it. The 
reasons lie on the surface. One of the most important duties of the 
chief budget officer will be to cut the estimates submitted to him by 
Cabinet officers. It takes no great stretch of the imagination to see 
the situation that will be created if an official connected with a par- 
ticular department cuts the estimates that come from other depart- 
ments. Think of a budget official passing upon the estimates of his 
chief. Inevitably there will be a feeling that the department to 
which the budget system is attached is being favored. In order that 
the system may have a fair chance, it must be in exactly the same 
relation to all the departments. With respect to it, just as,with re- 
spect to the President and Congress, the departments must be on 
the same plane. A budget officer representing the President will be 
in a very different position from a budget officer representing the 
Treasury. 

The argument is no less strong with reference to the relation be- 
tween the budget and the President. No matter where the budget 
system is placed, the President will be the final arbiter in important 
differences between the budget officer and the department heads. It 
will be much easier for him to settle these differences if the budget is 
part of his office than if it is connected with one of the departments. 
In the latter case appeal would first be taken from the budget officer 
to the head of the department and then to the President. This 
would put the President in the delicate position of having to decide 
between two of his Cabinet officers. With the budget officer a part 
of the President's Staff, the final conference would consist of the 
President, the budget officer, the department head and perhaps the 
head of the bureau affected — a much more promising assemblage 
for an objective consideration of the case. 

The budget officer will not be a mere reducer of figures. To be 
of the greatest usefulness, he will make it his business to keep the 
President informed of the activities of the various departments. He 
will follow up his work on the estimates each year by observing the 
way in which the appropriations are spent, continually reporting to 



ORGANIZATION FOR BUDGETARY CONTROL 47 

the President. This valuable service, it is obvious, can be rendered 
much better by an officer attached to the President's Staff, than by 
one attached to a department. Under the latter arrangement, in- 
deed, it would be rendered at a maximum of difficulty. 

As is well known, the Senate and the House compro- 
mised their differences by placing the Budget Bureau nomi- 
nally in the Treasury Department, but with the Director 
of the Bureau reporting directly to the President. Since 
the appointment of the present Director, the President has 
taken care to emphasize to the departmental heads that the 
Director is the representative of the President and that his 
requests should be treated as if the President himself made 
them. 

The arguments set forth in the foregoing quotation apply 
with slight modification to the organization for budgetary 
control of the private enterprise. The chief executive must 
be both the nominal and active head of the budgetary organ- 
ization. 

The Budget Committee 

In all businesses where a functional organization exists 
the budgetary program will usually be expedited and bene- 
fited by the establishment of a budget committee. This 
committee will consist of the principal functional executives, 
with the president as chairman. In a manufacturing busi- 
ness it will usually be satisfactory to have it composed of the 
president, the sales manager, production manager, treasurer, 
personnel manager, and controller or general auditor. In a 
merchandise business the president, merchandise manager, 
treasurer, personnel manager, and controller may be suffi- 
cient. 

Under the authority and direction of the president the 
budget committee considers all departmental estimates and 
makes changes and revisions as it may think desirable. No 



48 BUDGETARY CONTROL 

estimate is to be effective until it has received the approval 
of the budget committee. In case the budget committee 
cannot agree with reference to any estimate, the question in 
dispute is left to the president and his decision is final. In 
case the judgment of the president does not agree with that 
of the majority of the committee, he has the privilege of 
overruling them since he is the head of the budgetary organi- 
zation. A wise executive would take such a step, however, 
only in extreme cases, for the success of the budgetary pro- 
gram depends to a considerable degree upon the cooperation 
of the executives. 

In the consideration of the departmental estimates the 
budget committee may call on departmental heads to ex- 
plain reasons for the variations in their estimates from the 
estimates for past periods, or to explain why changes cannot 
be made which the committee thinks desirable. By this 
means the committee obtains full information on the sub- 
ject before making its decisions. When the departmental 
estimates have been approved by the committee and the 
president, they then become the working budgets for the 
departments. Of course they may have to be submitted to 
the board of directors for approval before becoming effective. 

At the end of stated periods of time, preferably monthly, 
the committee will receive reports showing a comparison of 
the performance for the period with the estimated perform- 
ance. For instance, it will receive a comparison of the sales 
for the month with the estimated sales for the month ; of the 
actual production with the estimated production ; and of the 
actual expenses of each department with the estimated ex- 
penses. On the basis of these reports it may make revisions 
in the budgets for the remainder of the budget period 
if it deems such revisions necessary. The receiving of such 
reports and the making of such revisions are a very impor- 
tant part of the committee's duties. 



ORGANIZATION FOR BUDGETARY CONTROL 49 

It is of little value to make budgets unless a check is 
maintained on those who are responsible for their execution, 
and unless such a check is maintained, proper attention will 
not be given to the preparation or the execution of the 
budgets. Furthermore, budgets deal with future operations 
and are therefore apt to be inaccurate. It is essential that 
these inaccuracies be discovered and corrected as quickly as 
possible. It is exceedingly unwise to make plans covering 
any considerable period of time and to follow these plans 
blindly without taking into consideration the changing con- 
ditions which could not be foreseen when the plans were 
made. 

Executive in Charge of Budgetary Procedure 

If the departmental estimates and the periodic reports are 
to reach the budget committee at the proper time for their 
consideration, a definite procedure must be established for 
their preparation and submission ; and after this procedure 
is established, there must be an executive responsible for its 
execution. Although the president is the head of the budg- 
etary program, he cannot assume responsibility for the direct 
supervision of the budgetary procedure and therefore must 
delegate this duty to some other executive. In a business 
where there exists a controller he may very well be charged 
with the direct supervision of the budgetary procedure. 

In many businesses there is no controller, and in many 
where there is an executive known by that title he in fact 
acts only as head of the accounting department and is not a 
controller in the correct sense of the word. In those busi- 
nesses where there is no controller the supervision of the 
budgetary procedure may well be delegated to a member of 
the staff of the president. This executive raay be given a 
distinctive title or he may merely be termed *' staff assist- 
ant to the president." Since the businesses which have a 



50 BUDGETARY CONTROL 

controller are by far in the minority, it will be assumed in 
the remainder of this discussion that a staff assistant of the 
president is the executive in charge of the budgetary pro- 
cedure. 

Duties of Executive in Charge of Budgetary Procedure 

Under the authority and direction of the president, the 
staff assistant to the president has general control and su- 
pervision over the preparation and execution of the budg- 
etary program. His general duties are indicated by the 
following summarized outline: 

1. To receive from the departmental heads the periodic estimates 

which will be discussed and illustrated in the following chap- 
ters. In order that these estimates may be made in the proper 
form for his use, he may design forms for the use of the de- 
partments in the submission of their estimates. 

2. To transmit these estimates to the budget committee with such 

recommendations as he may think necessary. He may com- 
bine and summarize these estimates so that they may be sub- 
mitted to the budget committee in the form which will make 
them, most useful to it. It is usually his function to prepare 
from the departmental estimates an estimated balance sheet 
and an estimated statement of profit and loss for submission 
to the budget committee and the board of directors. These 
show the estimated effect of the contemplated program on the 
financial condition and earnings of the company. 

3. To supply the budget committee with all the information avail- 

able which will assist it in the consideration of the estimates. 
He should have assistants whom he should use in the collecting 
of statistical data and the translating of these data into the 
form of reports and charts which will be useful to both the 
budget committee and the department heads. 

4. To receive from the budget committee the estimates as approved 

and transmit these to the departmental heads. 

5. To receive periodic reports prepared by the operating depart- 

ments or the accounting department showing the performance 
of each department during the budget period. 



ORGANIZATION FOR BUDGETARY CONTROL 5 1 

6. To transmit periodic reports to the budget committee showing a 

comparison between the estimated performance and the actual 
performance for the period for each department, and to make 
any recommendations with reference to revisions which he 
thinks necessary. 

7. To transmit to the departmental heads any revisions in the 

original estimates which have been made by the budget com- 
mittee. 

8. To recommend to the president and to the budget committee any 

changes in the budget procedure which he may think necessary ; 
and to enable him to make these recommendations, he should 
be continually making studies and doing research. 

The staff assistant usually acts as secretary to the budget 
committee, and in this capacity is constantly available for 
consultation with the members of the committee. He has 
the implied authority to do everything necessary to the 
proper performance of the duties expressly stipulated for 
him. 

Importance of Staff Assistant's Work 

It is important that the staff assistant in charge of the 
budgetary procedure should not be regarded as doing work 
of a clerical nature. His function is something more than 
the supervision of the budgetary routine. In the operations 
of the budgetary program many questions of policy will 
arise. The departmental executives will often differ with 
reference to these questions. It is the duty of the staff 
assistant to study these and be able to offer to the budget 
committee and the president the matured judgment of an 
impartial observer. His work brings him in touch with all 
the departments of the business and should enable him to 
have a more comprehensive view of it than is usually pos- 
sessed by the line executives. As a result he should be able to 
make recommendations and suggestions as to new methods 
and policies which will be beneficial to the business. He 



52 BUDGETARY CONTROL 

should also make a practice of collecting data which will 
serve as a basis of more accurate estimates. By these means 
he can become one of the most important executives in the 
organization. 

Departmental Executives 

The executive heads of the functional departments are 
responsible for the preparation of the estimates of their 
departments at the time and in the manner prescribed by 
the adopted procedure. They are also responsible in some 
cases for the periodic reports showing the performance for 
the period. Some of the periodic reports are obtained from 
the accounting department, while some are obtained from 
the operating departments. Usually the operating depart- 
ments will submit reports more quickly than the accounting 
department, and promptness is necessary in order to use the 
reports effectively. Any recommendations which a depart- 
mental executive desires to make with reference to changes 
in budgetary procedure will be transmitted in writing to the 
staff assistant to the president, who in turn will transmit it 
to the budget committee for consideration. 

There is a difference of opinion among executives with 
reference to the extent to which the departmental head 
should delegate the duty of preparing the estimates of his 
department. As explained in Chapter III, it is the opinion 
of the author that the preparation of the original estimate 
should be delegated as far as possible to the one who will be 
responsible for the carrying out of the estimate after it has 
been adopted. 

Board of Directors 

In many businesses the budgetary program after it has 
been formulated and approved is submitted to the board 
of directors. In case the program involves a radical change 



ORGANIZATION FOR BUDGETARY CONTROL 53 

in policy or the acquirement of a large amount of capital, 
they may deem it necessary to modify it. The staff assist- 
ant to the president should have available data which will 
serve to show the modifications which are possible and their 
effect on the program as a whole. 

If modifications are necessary, the board of directors 
may instruct the chief executive to prepare a budget giving 
effect to the changes which they desire. In this case all the 
departments may be required to submit new estimates, or 
the changes may be such that they can be made by the 
budget committee. In any case the changes as made must be 
transmitted to the departmental heads by the staff assistant 
to the president. 

Although it is well and proper to have the budgets sub- 
mitted to the board of directors for consideration and 
approval, they should be transmitted to it only after they 
have been put into completed form. It is obvious that the 
directors are not interested in the details of preparation, 
and therefore the budget committee should have completed 
its work before the budgets are sent to the directors. Un- 
doubtedly the tendency for the board of directors to give 
consideration to the budgetary program will be increased 
in the years to come. 



CHAPTER V 
THE SALES BUDGET 

Importance of Sales Information 

In the preceding chapters the fact has been emphasized 
that all of the functional departments of a business are 
closely related arid that the activities of each department 
are dependent to a considerable extent upon the activities of 
all the other departments. In fact it is because of this inter- 
relation and interdependence of departmental activities 
that budgetary control is necessary. It is difficult to con- 
sider the activities of any one department without consider- 
ing to some extent their effect on the activities of all the 
other departments, and vice versa. In the formulation of 
the plans of any one department for the ensuing budget 
period, it is necessary to consider at every stage of their 
development their effect upon the plans of every other de- 
partment. Modifications and revisions are often necessary 
in order to effect coordination. 

It will be necessary in the present chapter and in those 
which are to follow to discuss the functional departments 
separately, but it is deemed wise to emphasize again the 
interdependence of the activities of these departments, so 
that the reader will keep this characteristic of business 
organization constantly in mind. 

The initial step in the budgetary program is usually 
made by the sales department. The reason for this is easily 
seen. The object of the operations of a business is to make 
a profit, and sales conclude the process which results in the 
making of a profit. Until the sales take place, consequently 
no profit is realized. Whenever the saks are profitable, the 

54 



THE SALES BUDGET 55 

executives of a business desire to increase their sales, and 
they try to coordinate all the activities of the business to 
accomplish this end. It follows that the activities of the 
sales department exercise a very important influence over 
the activities of all the other departments. This influence 
is of primary importance in both a mercantile and a manu- 
facturing business. 

It is customary, therefore, for the sales department to 
prepare a sales estimate which sets forth the sales which are 
desired and deemed possible during the next budget period. 
This estimate must then be studied in comparison with the 
future possibilities of the other departments as set forth in 
their estimates, in order to arrive at a properly coordinated 
budget for the entire business. The revised sales estimate 
or the ' ' sales budget ' ' then becomes the working program of 
the sales department. 

Need and Importance of the Sales Estimate 

The owners or officers of either a trading or a manufac- 
turing industry of necessity must estimate the probable sales 
of their business for each season or fiscal period. These 
estimates may be made very unscientifically and be recorded 
quite informally, or they may be made as the result of a very 
careful analysis of all the factors involved and presented by 
means of a formal report. But, in any case, an estimate 
of sales must be prepared as a basis of planning for the 
future. 

In a trading business, the nature and amount of goods 
to be purchased depends upon the plans of the sales depart- 
ment. In a manufacturing business, the volume and nature 
of production is dependent on the sales estimated. If a 
sales estimate is not made by the sales department, the 
probable sales must be estimated by the purchasing depart- 
ment or the production department; otherwise these de- 



56 BUDGETARY CONTROL 

partments have no basis for their plans. It is the purpose 
of the present discussion to emphasize the point that it is 
properly the function of the sales department to prepare 
this estimate, and to explain the method by which it is pre- 
pared. 

It is evident that in a mercantile store goods must be 
bought and placed on the shelves or in the warerooms before 
they can be sold. It will later be explained how in a manu- 
facturing business goods may sometimes be sold before they 
are produced, but such is not the case in the typical mercan- 
tile business. Consequently, in this type of business, before 
the buyers can make contracts and select the qualities and 
kinds of goods that are to be offered for sale, the manage- 
ment must raake estimates, however scientific or unscien- 
tific, as to the volume and character of sales expected for 
any given period. 

The small retailer whose business is restricted to one 
particular specialized commodity, say a dealer in rare 
oriental rugs, may say that he will buy what he can and 
plan for the sale of the merchandise after he has it in his pos- 
session. But a large retail business, such as a department 
store, that sells many thousands of different items of mer- 
chandise, must set up a program of what sales are expected 
to be, if purchases are to be made intelligently in source 
markets all over the world and deliveries to the shelves of 
the store completed before the customers of the store come 
to buy. Even in the case of the dealer of oriental rugs it is 
probable that he will learn by experience that certain kinds 
or types of rugs sell more readily than others. When he 
makes his purchases, he will be guided by that experience 
and will seek the popular kinds of rugs for his antici- 
pated sales. In so far as he does this, he is estimating his 
future sales. In other words, he is making an informal 
sales estimate. 



THE SALES BUDGET 57 

Anticipated Sales the Basis for Action for All Departments 

Not only does the volume and nature of the sales antici- 
pated, as reflected in the sales estimate, affect the buyers in 
their selection of goods, but it also vitally affects the opera- 
tions and plans of the various functional managers of the 
business. The officers of the store who are responsible for 
providing proper space for counter stocks, for reserve 
stocks, and for wareroom stocks, must have before them 
some tangible data as to when such stocks will be purchased, 
when sold, and what volume of sales will be raade. In de- 
partment stores and mail-order houses, where large stocks 
are carried, this is especially important. 

The operating managers above raentioned must work 
with an estimate of sales in mind, so that they may secure 
the proper sales persons and then train them to meet the 
needs of the organization. Similarly the operating officials 
must anticipate the volume and character of sales to a fairly 
accurate degree, if they are to employ an economical num- 
ber of packers, wrappers, telephone operators, delivery men, 
and the like, and if they are to train these employees into an 
efficient working force animated with the service ideals of 
the store, and thoroughly familiar with the operations, proc- 
esses, procedures, and schedules in retail selling and order 
buying. 

The treasurer or other officer charged with the responsi- 
bility of financing the purchases and expenses of the store 
must have very definitely in mind the volume of revenue 
from sales that the store may reasonably expect to receive 
from week to week, and even from day to day. The owners 
themselves, or the president or general manager as their 
agent, must carefully study expected sales in investing 
capital in new divisions or departments of the store, in 
making additions or extensions of physical plant, or in mak- 
ing decisions concerning new forms of customers' credits. 



58 BUDGETARY CONTROL 

Place of Sales Estimate in a Wholesale or Retail Store 

In short, the owners and officers of a wholesale or retail 
store of appreciable size must set up a sales program for 
each season or fiscal period in order that the customer may 
receive service resulting from coordinated purchasing, oper- 
ating, financing, and plant maintenance and extension. 
For instance, in a department store, if the various depart- 
mental buyers who are purchasing goods in different 
markets are to work as a unit, they must know not only 
what volume of sales in their own particular lines they are 
anticipating by their contracts, but they must also know 
something of the character and volume of sales expected in 
all the other lines of the store, so that they may select and 
purchase qualities and quantities complementary and sup- 
plementary to the other lines of goods handled by the store. 

But the departmental buyers must not only work in 
harmony with each other ; they must work in harmony with 
the traffic manager, the superintendent of warehouses, and 
the superintendent of delivery service. The one vital point 
of contact between the selector of raerchandise and the 
operating man who handles the order for the customer, is 
that they both promise their work on the same expectancy 
or estimate as to volume and character of business. It can 
be readily seen, therefore, that comprehensive and accurate 
information with reference to sales anticipated is of utmost 
importance in the internal control and management of a 
modern wholesale or retail store. 

The Sales Estimate in a Manufacturing Business 

In a manufacturing business the sales estimate is as 
necessary for coordination of departmental activities as in 
the case of a mercantile establishment. The production 
manager must base his production program on the antici- 
pated sales; otherwise excess stocks will accumulate or orders 



THE SALES BUDGET 59 

will go unfilled. The plant engineer must plan his building 
and equipment program to meet the production program 
demanded by the sales estimate. The employment or per- 
sonnel department must consider the increased or decreased 
demand for employees which will result from the program of 
the next budget period. The purchasing agent must make 
contracts for raw materials and supplies and schedule de- 
liveries in order to meet the demands of the production 
budget. The shipping department must adjust its capacity 
to meet the demands of the sales program. The treasurer 
must know the estimated revenue from sales as well as the 
probable disbursements arising from the financing of the 
sales program and the consequent production program, in 
order to provide for the necessary funds. Thus each de- 
partment of the business is affected by the volume of busi- 
ness and the volume of business is determined by the amount 
of the sales. Consequently a knowledge of the amount of 
the sales anticipated is necessary in order to plan the opera- 
tions of the business in such a manner as to secure coordina- 
tion, and without coordination efficient administration is 
impossible. 

The Revised Estimate, or ^^Budget," the Result of Cooperation 

It may be well to state again that it is not intended to 
imply by the emphasis placed on the importance of the sales 
estimate that the sales department should determine the 
policies of the business as a whole. The following discus- 
sion will show that though the sales estimate is usually pre- 
pared originally by the sales department, the sales depart- 
ment in its preparation should take into consideration the 
plans and possibilities of the other departments. In any 
case, the revised estimate, or ''budget," which serves as 
the basis for future operations, is the result of the coopera- 
tive efforts of all the functional departments of the business. 



6o 



BUDGETARY CONTROL 



It is revised and modified by the functional officers and the 
budget committee before it is adopted in its final form. 

The purpose of the preceding discussion is to emphasize 
the need and importance of the sales estimate. It is now 
necessary to discuss its preparation and the method by 
which it is used. 

Threefold Basis of the Sales Estimate 

The sales estimate is a report which gives in a sum- 
marized but comprehensive form the sales which the sales 
department desires and deems possible during the next 
budget period. In the preparation of this estimate, infor- 
mation of various kinds must be considered, which informa- 
tion may be classified under the following general headings : 

1 . Knowledge of general plans and policies of the business. Such in- 

formation is obtained from the decisions of the executive offi- 
cers and the board of directors. 

2. Knowledge of trade conditions. Such information is obtained as 

a result of market analysis. 

3. Knowledge of the amount and nature of previous sales, as shown by 

the accounting records. Such information involves sales 
analysis arid comparisons. 

It is necessary to discuss each of these briefly. 



I. The General Plan and Policies of the Business 

In most businesses, plans are made from time to time 
which affect the sales policies and the volume of sales of the 
business. A few examples will suffice to make clear the 
importance of considering such plans in making the sales 
estimate. 

In many businesses there is a special department called 
by various names, such as sales engineering, sales promo- 
tion, sales development, or sales research department, whose 
function it is to study sales possibilities and to recommend 



THE SALES BUDGET 6 1 

changes in sales policies and methods. As a result of such 
recommendations new lines may be added ; old lines may be 
dropped; new territories may be entered; new agencies or 
branches established ; new methods of distribution put into 
effect; changes in prices or terms of sale made; additional 
advertising carried on ; more salesmen added ; and numerous 
other changes made. 

Whether or not a separate department is maintained to 
carry on work of the sort mentioned, such changes are made 
from time to time by all progressive firms, and the effect of 
such changes must be given careful consideration in the 
preparation of the sales estimate. In some cases such 
changes are decided upon by the chief executive of the sales 
department, but since they affect to some extent the activi- 
ties of all the other departments, it is customary for them 
to be considered by all the functional executives before they 
are adopted. In the case of some sales policies which will 
vitally affect the business, it may be necessary for the board 
of directors to judge if so radical a change as that suggested 
by the program is desirable for the business. In a business 
where proper methods of management are followed, the 
effect of new policies will be considered before they are 
adopted. Therefore it is not difficult to give effect to these 
policies in the sales estimate. The importance of giving 
careful consideration to their effect cannot be overestimated. 

2. Market Analysis 

Although the questions concerning market analysis are 
primarily problems of the larger one of sales management, 
they are nevertheless inseparably interwoven with a con- 
sideration of budget-making and control. In fact, neither 
market analysis nor sales analysis can be intelligently con- 
sidered apart from the other. Each serves as a check upon 
the other. Market analysis and statistical records show to 



62 



BUDGETARY CONTROL 



what extent the potential demand has been satisfied and 
whether or not it is profitable to try to satisfy it. As has 
been pointed out before, the purpose of making sales is to 
gain a profit. But not every demand for goods is one which 
can be satisfied on a profitable basis. It is the function of 
accounting and statistics to assist in the determination of 
the results of past sales and thus to indicate the probable 
results of anticipated sales. 

To mention all the factors which must be considered in 
making an analysis of the market in the case of a retail, 
wholesale, or manufacturing business is of course impossible. 
The buying power of the comraunity, as reflected in its 
savings bank deposits; the industrial growth of the com- 
munity, as reflected in its pay-rolls; the condition of crops 
and the profits of the farmer and stock- raiser in the surround- 
ing agricultural region; transportation conditions in their 
relation to the delivery of goods ; climatic changes and their 
effect on seasonable lines ; these and many other general and 
local trade factors will each have a bearing on the sales to be 
expected for a retail store. Then the store will have to con- 
sider many local factors of importance to itself, such as new 
buildings and street improvements near the store; fire 
hazards ; relationship of management to state officials with 
reference to state laws of employment, etc. ; new forms of 
taxes adopted or proposed ; character of store management ; 
and the like. 

In a wholesale or manufacturing business many of the 
factors above mentioned will have to be taken into account, 
and in addition others of a more general nature. For in- 
stance, general industrial and agricultural conditions 
throughout the territory reached by the retailers or jobbers 
to whom the company sells must be considered, and in de- 
ciding on methods of selling and advertising, and in estimat- 
ing results, the density and character of the population in 



THE SALES BUDGET 63 

both old and potential territory must be taken into account. 
It will be understood that the "business cycle" must be 
given careful consideration in the determination of the sales 
possibilities of both a mercantile and a manufacturing firm. 
In some businesses it is the function of the sales engineer- 
ing department, or some other department performing the 
same function, to make the market analysis and present the 
data which serve as a basis for the sales estimate. In any 
case these data must be available if accurate forecasts are 
to be made. It is beyond the scope of this discussion to 
treat of all the problems involved in sales administration 
and management. The purpose of the present discussion 
is to emphasize the necessity for the careful and scientific 
consideration by the sales department of all the factors which 
may influence future sales, if the sales department is to pre- 
pare a sales estimate which will serve as a proper basis for 
coordination of departmental activities. 

3. Sales Analysis 

Having in mind that only a few of the usual factors in 
sales management have been mentioned, it seems at first 
thought as if it were impossible to use accounting records 
and reports to any advantage in estimating what the volume 
and character of sales are likely to be. The outstanding 
fact is that a sales program must be made, and in fact is 
made in the conduct of all businesses. Even if the presi- 
dent only ''hopes to do slightly better this period than the 
preceding one," the sales program is the result of taking 
the revenue accounts of the last period with an additional 
margin of possibly 5 per cent. The directors who ask their 
ofiicers to "hold your own despite the decline in the mar- 
ket or other conditions," are setting up a very definite 
standard of performance and accountability. The estimate 
of sales is based on the actual sales of the preceding period, 



64 BUDGETARY CONTROL 

or periods, plus or ramus certain amounts or percentages. 
This modification is due to a more or less careful consid- 
eration of various general trade factors and various trade 
conditions peculiar to the business itself. 

In some businesses it is the custom to take past sales and 
apply a more or less arbitrary percentage in order to arrive 
at the estimated sales of the following period. This method 
is unscientific and is usually inaccurate, for it does not take 
into account trade conditions or changes in market policies 
on the part of the business, and such changes occur almost 
continuously in most businesses. It is highly important 
that past sales be considered very carefully in making the 
sales program, but it is not wise to follow such statistics 
slavishly. 

The sales accounts of a business tell the owner what 
past sales have been. If the total sales are credited to one 
account only, there is still the very valuable analysis by 
days, weeks, and months, of cash and accounts receivable 
gained by the store through creating sales, although this 
information may not be classified in a convenient form, and 
so may be difficult to obtain, i If a proper analysis of sales 
is maintained by means of accounting or statistical records, 
there will be available information not only of value in mak- 
ing the sales estimate, but also of service to the various 
departmental managers. Although it is not safe to assume 
without investigation that the same ratio between various 
classes of sales will continue year after year, if the past 
tendency is known a fair estimate of the future ratio can be 
made, i For instance, if the sales analysis shows that for the 
past five years the cash sales have averaged 25 per cent of 
the total, and the sales on account 75 per cent, the treasurer 
can usually assume that approximately the same ratio will 
hold good during the next year unless there are conditions 
which it is known will change the ratio. 



THE SALES BUDGET 65 

Various Kinds of Sales Information Desired 

After the probable ratios between the various classes of 
sales are known, the departmental executives can use them 
in estimating the effect of the proposed program on their 
activities. To understand the analysis which should be 
made, it is necessary to consider briefly the nature of the 
information which may be desired. 

If the problem is to estimate the sales for a retail store 
for the three months beginning June i, the first question 
asked of the accountant is likely to be: What were the 
sales of last summer by days and weeks? The representa- 
tive, or representatives, of the sales department who are 
responsible for the preparation of the sales estimate asks 
this in order to be able to make an estimate for the current 
period. The sales department, in turn, must answer the 
question of the amount of sales anticipated for this summer. 
In the preparation of the sales estimate, this information 
must be obtained and made available. The merchandise 
manager asks the question of the sales department in order 
that he may be equipped to fix delivery dates in his con- 
tracts with manufacturers and wholesalers. The operating 
superintendent asks it because he must estimate the number 
of employees required through the normal vacation period. 
The treasurer asks it because he must finance the purchase 
invoices, the store pay-rolls, etc. Even the finance com- 
mittee of the board of directors may ask it if they are plan- 
ning certain changes in the financial plans of the company. 

In addition to this information, each officer may ask for 
data on last year's sales from the viewpoint of his particular 
responsibility. The operating superintendent asks, "What 
percentage of sales last summer were counter sales? What 
percentage of sales were over the telephone?" The treas- 
urer asks for data as to cash sales, sales on monthly accounts, 
and instalment sales. The traffic manager asks for the 



66 BUDGETARY CONTROL 

amount of sales to out-of-town customers by express and 
by freight. These and many other questions of a similar 
nature will be asked of the accounting department, and, in 
order to be able to answer them, a proper analysis and classi- 
fication of sales data is necessary. 

Classification of Sales Data 

No arbitrary classification of sales data can be given, for 
the analysis and classification made is determined by the 
information desired by the various functional managers. 
But it is safe to say that in planning for the future the offi- 
cers and managers will desire sales to be classified in some or 
all of the following ways : 

1 . By commodity or department 

2. By terms of sales 

3. By method of sale 

4. By method of delivery 

5. By territory of customers 

6. By salesmen 

7. By volume of sales to individual customers 

8. By nature of customers 

9. By rush vs. normal deliveries 

The purpose of each of these classifications should be evi- 
dent to the reader. 

In a manufacturing business a shorter classification may 
be required. This is due to the fact that it handles and sells 
its commodities more directly than a trading company. 
Where goods are sold in large quantities, as is usually the 
case in the disposition of products by a manufacturing busi- 
ness, the problems of selling are less complicated. In such 
a business sales may be classified as follows : 

1. By commodities or groups 

2. By territories 

3. By salesmen 

4. By customers 



THE SALES BUDGET 67 

In a manufacturing business the terms of sale, method of 
sale, and method of delivery are usually uniform for all 
classes sold. Where this is true, no classification to indicate 
these is necessary. 

The classifications of sales stated above are intended to 
be suggestive rather than all-inclusive. They are indica- 
tive of what may be done in the classifying of sales in order 
to make available information for the preparation of the 
sales estimate and for the use of the departmental managers 
in making their plans. 

Terms in Which Estimate Is Made 

The terms in which the estimate should be made are 
dependent on the nature of the business and the purpose for 
which the estimate is to be used. In the past, estimates of 
sales and purchases and expenses have been made by some 
businesses for the purpose of financial control only. As a 
consequence they have been made in terms of value. For 
the purposes of financial control all estimates must be stated 
in terms of value; but for the purpose of sales, production, 
and purchases control, estimates must be stated in terms of 
physical quantities and not in terms of value only. There 
are possibly a few cases where sales and purchasing control 
may be effected in terms of value, but these cases are rare. 

In a manufacturing business it is essential that the sales 
estimate be made in terms of physical quantities, for pro- 
duction orders are issued for a certain number of each item of 
goods produced and not in terms of dollars and cents. It is 
not enough for the production department to know that the 
estimated sales for the budget period are $3,000,000. It 
must know how many hundred of each of the items which 
the company offers for sale will be sold during the period, so 
it will know how many must be produced to meet the sales 
requirements. It is necessary that the sales estimate not 



68 BUDGETARY CONTROL 

only state the sales to be made, in terms of physical quanti- 
ties, but it is also necessary that it state separately the sales 
of each item of goods which is offered for sale. Some com- 
panies make estimates in terms of sales classes or groups. 
These are of little value from the viewpoint of coordinating 
sales and production. 

Planning Sales in Terms of Items 

Sales orders are made in terms of particular items of 
commodities, and if these items are to be available, produc- 
tion must be planned in terms of these items. A factory 
may have a large inventory and yet be unable to fill sales 
orders if the particular items called for by these orders are 
not on hand. To make the sales estimate serve as a basis 
for the coordination of sales and production, it is essential 
that the planning of sales be in terms of items and not in 
terms of values or groups or classes. 

In most cases the same principle holds true in the retail 
or wholesale store. A customer does not want a pair of 
shoes but the pair of shoes of his particular size and shape. 
In order that the merchant may know how many customers 
want each particular make, size, and style and that he may 
procure the goods in advance to meet these demands, it is 
necessary to have records which will give such information 
with reference to past sales, and will furnish a basis for mak- 
ing accurate estimates of future requirements. Thus it is 
in all lines of merchandise — the demands of the customers 
call for particular items, and the sales and purchase budgets 
must be made accordingly. It is of course true that, in the 
case of goods subject to wide changes in fashion, estimates 
by items cannot be made accurately. But even in this case 
past statistics will show a fair indication of the customers* 
demands for different styles and kinds. 

The necessity for making the sales estimate in terms of 



THE SALES BUDGET 69 

items makes the task of preparing the estimate much more 
complex in many cases. The different items of merchandise 
sold by some firms run into the thousands. To estimate 
sales and plan production in connection with each of these 
items is a very difficult problem. In some cases the number 
of items may be so great that this is well-nigh impossible. 

Under such conditions some method must be devised 
which will obtain the necessary results without the incur- 
rence of prohibitive labor. In most cases a study of the 
sales of a firm handling thousands of items will show that the 
bulk of its sales is composed of a comparatively few items 
and that the remainder are slow-moving items of which the 
number of sales are few. This may make it possible t(i^elect 
a list of ''significant" items which will contain those which 
constitute the bulk of the sales. In a recent case on which 
the author was employed, it was found that of 20,000 
items, 682 constituted approximately 75 per cent of the 
total sales* 

Use of "Key" Items in Sales Estimates 

In some cases it is found that there are certain "key" 
items of which the fluctuations in sales govern the fluctua- 
tions in a number of similar items. For instance, there may 
be a group of items which are the same except for size, and 
there may be one particular size in the group for which there 
is the greatest demand. It may be found that the sales of 
the less popular sizes fluctuate year by year in proportion to 
the fluctuation in the sales of the most popular size ; and if 
this condition can be shown to be approximately correct 
it is then necessary to have the sales department estimate 
only the sales of the " key " items, the statistical department 
estimating the sales of the remaining items. It is only in 
certain businesses handling certain lines of merchandise that 
there exists a probability of such a condition arising, but 



70 BUDGETARY CONTROL 

where it does arise it greatly facilitates the preparation of 
the sales estimate. 

When it is possible to select significant or key items, the 
sales and production budgets may be made, in terms of 
items, for the items on the significant list. The remaining 
items can be grouped by classes and the budgets prepared 
on them in terms of classes. Although the budgets on the 
groups will be in most cases unsatisfactory from the view- 
point of coordination of sales and production, this is not of 
so great importance for these items, which have a low turn- 
over and are slow-moving, inasmuch as it is not difficult to 
provide sufficient inventory to meet the sales. By a proper 
system of inventory control, excess quantities can be 
avoided. For the purpose of the financial budget, the 
group budget on the non-significant items will usually serve 
satisfactorily. 

It is not intended to imply by the foregoing discussion 
that budgets prepared in terms of classes or groups of items 
are desirable. It is intended only to suggest that this is 
one method of procedure when the items sold by a company 
are exceedingly numerous. If such a plan is followed, it 
will usually be found expedient to add gradually more and 
more items to the significant list as the work proceeds. If 
such a study is begun, it will usually result in the elimination 
of many of the "non-significant" items which it will be 
found are unprofitable and unnecessary. In the end this 
process will result in the proper budgeting of all items. 



CHAPTER VI 
THE SALES BUDGET (Continued) 

Responsibility for Preparing the Sales Estimate 

As stated in the preceding chapter, the sales estimate is 
prepared by the sales department. As to which particular 
unit of the sales organization should be responsible for its 
preparation, an arbitrary rule cannot be formulated. In 
each case the organization of the company and its selling 
methods must be taken into consideration. 

In a department store the departmental managers are 
usually held responsible for the preparation of the depart- 
mental estimates, and these are combined by the merchan- 
dise manager to make the estimate for the entire business. 
The departmental manager of course will consult with his 
assistants in the preparation of his estimate. 

In a wholesale or manufacturing business which employs 
traveling salesmen, each salesman may be asked to make 
an estimate of the sales in his territory for the budget period. 
Such estimates will of course have to be checked very closely 
and revised by the central sales office in the light of the data 
which it should have available. 

In a business which sells its products through branches, 
each branch may be requested to make an estimate of its 
sales. These estimates, like those of the salesmen, should 
be carefully checked by the central sales office. 

When either salesmen or branches are requested to make 
an estimate of their sales, they should be provided with a 
record of their sales for one or more past periods, in order to 
be able to use these data in making an estimate of future 
sales. 

71 



72 BUDGETARY CONTROL 

Those who favor the making of estimates by salesmen 
and branches contend that those in closest touch with the 
customers are best able to judge future demands. There 
are some companies, however, who will not rely at all upon 
the estimates of the sales force. Instead, they favor the 
collection of data by the central sales office and the employ- 
ment of special investigators who make a survey of the sales 
territory and report on possibilities. Using the data with 
reference to population, industrial conditions, etc., and the 
reports of the special investigators, in connection with past 
sales, they formulate the sales estimate. In some cases, 
after the estimate is prepared by the central office, it is sent 
to the branches or to the salesmen for criticism. 

Relation of Inventory Requirements to Sales Estimate 

If a business has branches which carry an inventory of 
merchandise, a further complication arises in connection 
with estimating their requirements, since the amount de- 
sired by them from the parent company is dependent not 
only upon their anticipated sales, but also upon the condi- 
tion of their stocks . Their inventories may be below normal 
on some items and show an excess on others. This condi- 
tion is especially apt to exist at the time a system of budget- 
ary control is installed. After the system becomes effective, 
material excesses or shortages in inventories should be 
eliminated, except in rare cases. 

Each branch must of necessity report the condition of its 
inventories for each budget period, whether or not it is held 
responsible for initiating the sales estimate. Since the sales 
estimate must be submitted previous to the beginning of the 
budget period in order that the production budget or pur- 
chase budget may be prepared for use by the beginning of 
the period, it is necessary for each branch or selling unit 
which carries an inventory to estimate its inventory at both 



THE SALES BUDGET 



73 



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74 BUDGETARY CONTROL 

the beginning and the end of the budget period. This of 
course adds another difficulty to the making of an accurate 
estimate. To illustrate more clearly the nature of the in- 
formation which the branch or selling unit must submit, a 
typical illustration may be taken. 

The X Manufacturing Company distributes the major 
part of its product through its branches, but sells some goods 
to jobbers. The branches make the principal part of their 
sales from stock which they carry, but take sorae orders 
which are shipped direct from the factory. The general 
sales office submits to the branches a form ruled as shown 
in Figure 2. 

The first column will be filled in by the general office. 
If the detailed sales records are kept at the general office, it 
also will fill in the second column. If, however, these 
records are kept at the branch, the branch will fill in this 
column. The remaining columns are filled in by the branch. 
Column (6) equals the sum of columns (3) and (4) minus 
column (5). Column (8) equals the sum of columns (6) 
and (7). In filling in column (4), it is necessary for the 
branch to have in mind some such terms as a "thirty-day" 
stock or a "sixty-day" stock. After the estimated sales for 
the period are determined, it is only a mathematical proc- 
ess to obtain the estimated inventory at the end. The 
foregoing illustration is given in order to indicate some of 
the problems which may arise in the making of an accurate 
sales estimate. 



Revision of Sales Estimate According to Production 

After the sales estimate is submitted by the unit of the 
sales department which is held responsible for its prepara- 
tion, it should be studied by the staff officers and revised in 
the light of their information and judgment. In the case 
of a manufacturing industry, it must be revised in the light 



.1 



n 



THE SALES BUDGET 75 

of production capacity. It is useless to formulate a sales 
program which is beyond the capacity of the production 
department to satisfy. Consequently, data must be ob- 
tained which will show production capacity. In order for 
this to be accurate and comprehensive, it is necessary to 
obtain data which will show machine capacity. This neces- 
sitates the preparation of a card for each machine used in 
the process of manufacturing, showing the operations per- 
formed on the machine and its capacity in the performance 
of these operations. It is then possible to determine 
whether the quantities called for by the sales estimate can 
be produced. If not, it is necessary to determine which 
items should be reduced or eliminated. 

Revision of Sales Estimate in Terms of Profit 

Another important factor in deciding the desirability of 
the sales program proposed by the sales department is the 
estimated profit. It is desirable that the profit to be ob- 
tained by the sale of each item called for by the sales esti- 
mate be determined, if possible. It is undesirable toproduce 
and sell an article which does not yield a satisfactory profit 
if it can be prevented. Sometimes, however, because of 
competitive conditions it is necessary to sell certain items 
in order to meet sales demands for a complete line of articles. 
For instance, in the sale of valves, dealers find it necessary 
to carry several sizes in order to meet the demands of their 
customers. Some manufacturers produce all these sizes 
so that other manufacturers, in order to meet the demands 
of the dealers, may be required to carry a complete line for 
fear the dealer will place his order with the manufacturer 
from whom he can obtain a complete line. That a complete 
line may be maintained, it may be necessary for the manu- 
facturer to produce certain sizes which he is unable to pro- 
duce and sell at competitive prices without incurring a loss. 



76 



BUDGETARY CONTROL 



In the 



of the sales 



revision ot tne sales estimate in terms of profit, it 
is necessary to give careful consideration to the problem of 
providing complete lines, so that items may not be elimi- 
nated which will result in decreased sales of other items. 
On the other hand, the sales department has a tendency to 
overemphasize the necessity for complete lines, and care 
must be exercised to prevent the carrying of too many un- 
profitable items. There is considerable agitation at the 
present time for standardization. It is to be hoped that 
this movement will develop and will result in the elimination 
of many specialties, especially in the case of goods which are 
adapted to standardization. Such standardization will 
greatly simplify the problem of budgetary control. 



Consideration of Maximum Gross Profit 

In revising the sales estimate in terms of profit it is 
necessary to consider not only the profit which has resulted 
from past operations, but also the probable profit which will 
result from the anticipated operations. Changes in method 
or volume of production, as well as changes in method or 
volume of sales, may affect materially the profit obtained. 
In order to estimate more accurately the effect of these 
changes in production or sales it is desirable to consider the 
cost of production and selling and administrative expense 
and the effect of the new program on these items. It is 
imperative that careful consideration be given to these fac- 
tors in the revision of the sales estimate. 

The sales program must provide for the maximum profit 
that trade conditions will permit consistent with the perma- 
nency of the business. Here is one of the vital points in 
making over the sales estimate of volume into a sales pro- 
gram. The management must decide not only what in- 
crease in business is desired, but also what volume of busi- 
ness can be had at a maximum gross profit of selling price 



THE SALES BUDGET ']'] 

to the customer over the purchase price or cost of produc- 
tion. Consequently the estimated vohime of each Hne, 
even of each class and kind of goods, must be re-estimated 
at the volume that will produce the greatest amount of 
gross profit. Obviously it is better, from the standpoint of 
gross profits, to plan to sell $120,000 of merchandise at 30 
per cent gross profit, than it is to sell $140,000 at 25 per cent. 

Revision of Sales Estimate in Terms of Selling Administrative 
Expense 

It is to be kept in mind that gross profit is not the only 
consideration. Handling cost may more than offset gross 
profit. There is more net profit in selling $100,000 of mer- 
chandise over the counter for cash at a gross profit of 15 per 
cent and an operating and overhead expense of 1 1 per cent, 
than there is in selling $200,000 by the instalment plan at a 
gross profit of 27.5 per cent and an operating and overhead 
expense of 26.2 per cent. It follows that the re-estimated 
sales must be gone over again from the standpoint of ex- 
pense. Sometimes it is difhcult to obtain accurate informa- 
tion with reference to the expense of selling different lines 
or items. When possible, such statistical analysis should 
be maintained as will provide this information. In some 
cases the cost of obtaining such statistics is prohibitive. 
It is then necessary to resort to tests and estimates. From 
time to time studies can be made, and these may serve as 
the basis for drawing up fairly accurate estimates. These 
estimates, in turn, may be used to judge the profit possibili- 
ties of various lines or classes. 

Revision of Sales Estimate According to Financial Requirements 

In the execution of sales and production, finances are 

required. An important factor, therefore, which must be 

given careful consideration in the formulation of the sales 



78 BUDGETARY CONTROL 

program, is the financial requirements. There are two 
ways in which the financial requirements may be considered. 
After the sales estimate has been revised, taking into con- 
sideration production capacity, profits, and the like, the 
amount of capital required to execute this program may be 
estimated. If this amount is in excess of that which the 
financial resources of the business will permit to be expended, 
it is necessary to revise the sales program. In making this 
revision the various factors previously discussed will be 
taken into consideration. 

Another method of considering financial requirements 
is in connection with the revision of the original sales esti- 
mate. The amount of capital required to finance each 
item of merchandise listed on the sales estimate may be 
indicated and this factor considered in deciding which items 
to reduce, in case reduction is necessary. In any case, after 
an estimate has been made of the activities of all the depart- 
ments of the business, it is necessary to prepare an estimate 
of receipts and disbursements, based on the departmental 
estimates, and to revise the departmental estimates if 
necessary, to bring them into harmony with a workable 
financial program. The process involved in the making 
of the financial budget will be discussed in Chapters 
XIX and XX. 

Formulation of the Sales Program 

In the previous discussion the most important factors 
which must be considered in the revision of the sales esti- 
mate have been explained. It should be realized, of course, 
that no attempt has been made to treat of all the factors 
which may need to be considered in particular cases. If 
the sales estimate is considered and revised in the manner 
suggested, the result will be the formulation of a sales pro- 
gram based on the following: 



THE SALES BUDGET 79 

1. Past sales as reflected in the sales accounts of previous years. 

2. The general plans and policies of the business as reflected by de- 

cisions of the executive officers. 

3. Trade conditions as determined by the study and research of the 

sales department. 

4. The judgment of the sales unit (or units) , which makes the original 

estimate. 

5. The judgment of the central sales office, which reviews the original 

estimates and makes such changes as it deems necessary. 

6. The production or purchasing capacity of the business as reflected in 

the production and purchase estimate. 

7. The gross profit-earning capacity of the different lines or items. 

8. The selling and administrative cost involved in handling different 

lines or items. 

9. The financial requirements of the program contemplated. 

10. The coordination of all the departmental estimates into a well- 

rounded program for the business as a whole. 

11. The sales budget, showing the volume of operations which the 

sales department is expected to perform, based on the budget 
of the business as a whole. 

The process of making the sales program is not a simple 
one. Rather a sales program must be thought of as a com- 
bination of several estimates. It is a statement of past 
experience modified by future plans, which are in turn modi- 
fied by trade conditions. 

Additional Factors in Determining Sales Program 

Many factors have to be considered in determining the 
proper sales program. In the case of a new business the 
ideal sales program may be one that plans for all the sales 
that trade conditions will permit, the only restriction im- 
posed by the owner being that no line may be handled at a 
net loss. Once a business is well established, however, it is 
not likely that this will be the sales program adopted. Ex- 
perience will show that some lines can be handled with 
greater profit than others, because of the fact that the loca- 



8o BUDGETARY CONTROL 

tion attracts a certain class of customers whose general 
demands are for these profitable lines. Furthermore, cer- 
tain of the personnel of the store will show greater aptitude 
in one or more lines. The obvious correction in this case is 
to strengthen the personnel, although that may be a matter 
of years of development. Thus, in many ways the estab- 
lished business may come to have a personality, a policy, a 
class of trade, a place of its own that can be deflected only 
by degrees, and this has an important bearing on its sales 
program. 

Since so many factors have to be considered in the for- 
mulation of the sales program, it is possible for it to forecast 
only approximately the operations of the sales department. 
Consequently the sales program must not be regarded as an 
arbitrary rule or regulation, or as an unchangeable order to 
do certain definite things. A real sales program is a state- 
ment of profits that seem possible under conditions so far 
as conditions can be foreseen. The form of the statement is 
in the tangible and understandable terms of estimated sales, 
but the purpose and meaning of the program is to arrive at 
net profit results. If conditions change after the sales pro- 
gram is set up, then the sales program will be changed just 
so far as the contracts and decisions made under the pro- 
gram can be changed. In order to effect these changes, a 
proper system of reports which will serve as a basis for con- 
trol of the sales budget is necessary. 

Control over the Sales Budget 

As suggested in the preceding paragraph, the sales budget 
is a preliminary statement of the anticipated operations of 
the sales department. Other departments, by means of 
their budgets, attempt to coordinate their activities with 
those of the sales department, as shown by the sales budget. 
As the budget period proceeds, it is necessary to take into 



THE SALES BUDGET 8 1 

consideration the variation of the actual operations of the 
sales department from its estimated operations. It is 
necessary that a comparison be made at frequent intervals 
in order to determine the amount of this variation, so that 
revisions may be made in the sales budget for the remainder 
of the budget period, provided the comparison indicates 
that such a revision is necessary. 

Effect of Revision of Sales Budget on Other Budgets 

After the sales budget is revised, it is necessary to revise 
the other budgets which are affected thereby. For instance, 
a sales budget may be made for the first three months of the 
year, and a production budget prepared to meet the sales 
program. At the end of January a comparison may show 
that sales made during the month are 50 per cent less than 
the estimated sales, and indications are that a like decrease 
will take place in February. The sales budget should then 
be revised and the production and financial budgets changed 
to correspond, if such changes are possible. In some cases 
commitments may have been made which make a complete 
revision of the other budgets impracticable. At least some 
revision, however, is usually possible. In the same manner 
comparisons should be made in connection with the other 
budgets, for if any of these changes are found necessary, 
they may make a revision of the sales budget necessary. 
For instance, if the production program had fallen down, it 
may be necessary to decrease the sales budget because of 
the inability to fill orders. 

Reports from Sales Units 

In order to raake a revision of the sales budget, it is 
necessary to have regular reports from the sales departments 
showing what the sales have been. Usually these reports 
are made monthly. If there are several units of the sales 



82 BUDGETARY CONTROL 

department making sales independently of the central sales 
office, it is necessary to have a separate report from each of 
these units. For instance, if a business has ten branches, 
each making sales from its own stock, it will be necessary to 
have reports from each of these branches showing the sales 
made, in order that the correctness of the original estimate 
can be judged and, if necessary, revisions made. 

Sales Orders vs. Shipments 

In making a comparison between sales and estimated 
•sales it is necessary to interpret ''sales" to mean orders re- 
ceived rather than goods shipped. Otherwise there may 
be a wide variation between the sales made and the sales 
estimated, which is not due to the fact that the original 
estimate was incorrect. The goods may not have been 
shipped because of the failure of the purchasing department 
or the production department to supply the goods. If the 
sales department obtained the orders, it has fulfilled its 
function. In revising the sales budget it is also improper to 
consider shipments, since it is the orders received, and not 
the shipments made, which indicate the possibilities for 
the remainder of the period. In revising the production 
budget it will be necessary to consider the shipments in order 
to determine the shortage or the excess existing. In con- 
sidering the orders received for the purpose of comparing 
sales with estimated sales it is necessary to exclude those 
received for future delivery. 

Method of Revising Sales Estimate 

In case it is found necessary to revise the sales estimate 
because of a falling off of orders, it is possible to determine 
which items should be reduced, for the orders will be classi- 
fied by items and the different items will be changed in pro- 
portion to the orders received for that item. In case the 



THE SALES BUDGET 83 

sales budget must be revised, because of a change in some 
other budget, such as the production budget or the financial 
budget, it is necessary to decide which items on the sales 
budget should be changed. Some firms list the items on 
the budget on a priority basis. In case some items must be 
reduced due to revisions in other budgets, the reduction is 
made on the last item on the list. If an increase seems de- 
sirable, the first item on the list is increased. The use of 
the priority list is of more significance in the case of some 
budgets than it is in connection with the sales budget. For 
instance, in the case of the plant and equipment budget it 
is a very practicable method of providing for a revision. 

Source of Information Used in Formulating and Controlling the 
Sales Budget 

It is not always practicable or feasible to obtain from 
the formal accounting records all the information needed to 
serve as a basis for formulating or controlling the sales 
budget. A considerable part of such information may be 
obtained from statistical records kept in the various depart- 
ments, or it may be obtained from a central statistical de- 
partment. The majority of up-to-date sales departments 
are constantly gathering statistics which will serve as a basis 
for forecasting future sales. In many cases a special depart- 
ment is maintained for this purpose. These data are useful 
in making the sales estimate. The operating department 
may keep a record of the method of delivery ; the advertising 
manager may have the sales tickets tabulated in his office 
to indicate sales by territories; other officials may record 
other data which they need. 

In many businesses tabulating machines are used to 
collect the statistical data needed by the various depart- 
ments. By means of cards which are punched to indicate 
various classifications of data and which are then sorted 



84 BUDGETARY CONTROL 

and assembled it is possible to obtain various kinds of data. 
In case considerable statistical information is necessary the 
tabulating machines are desirable. In any case the account- 
ing records can provide quite useful analyses if these records 
are properly constructed and operated, the principal obstacle 
to this being the conception of bookkeeping as a science of 
formulas for the all important purpose of arriving at net 
profit or loss. Once a set of revenue accounts is rightly 
considered as a continuing analysis of transactions, no prac- 
tical difficulty will be experienced in keeping as many co- 
equal sets of sales accounts as the making of the well-con- 
sidered sales program demands. 

Difficult Problems in Preparing Sales Budget 

The chief difficulties encountered in the preparation of 
the sales budget have been indicated in the preceding dis- 
cussion. In order that these difficulties may not be disre- 
garded or minimized, it is deemed desirable to summarize 
them here. They may be stated as follows: 

1. Market fluctuations, which make it difficult to forecast future 

sales. 

2. Seasonal fluctuations, which make it difficult to coordinate sales 

with production. 

3. Inadequate statistics with reference to past sales, which make it diffi- 

cult to estimate future sales. 

4. Lack of standardization, which results in one firm handling hun- 

dreds of different items, with the consequent difficulty of esti- 
mating sales on each item. 

Although it is impossible to eliminate these difficulties, it is 
possible to overcome them to a considerable extent. 

By carrying on proper research work and by collecting 
proper statistics it is possible, to some extent, to estimate 
market fluctuation. Of course, in periods of violent read- 
justments following a panic or a war it is difficult to estimate 



THE SALES BUDGET 85 

the future trend of the market. The only resource, then, 
is to make the budget period as short as possible, keep the 
resources of the business in a liquid condition so that they 
will be adaptable to sudden changes, gather statistics at 
frequent intervals to make possible a revision of the budgets, 
and make such changes as are found necessary as quickly as 
possible. 

Seasonal fluctuations may be provided for in some cases 
by having seasonal budgets so that the seasonal fluctuations 
can be provided for at each budget period. If it is impossi- 
ble to do this, it is necessary to plan operations so as to meet 
these seasonal fluctuations and to make the budgets and 
budgetary reports correspond. The method of planning 
production to meet seasonal sales will be discussed in a later 
chapter (Chapter IX). 

Inadequate statistics often present a very serious diffi- 
culty. The question sometimes arises as to the advisability 
of attempting budgetary control before more adequate 
statistics are obtained than are at hand. Although it may 
be impossible to make correct budgets on the basis of infor- 
mation available, there is a decided advantage in commenc- 
ing the budgetary program and developing the statistical 
records as the work proceeds. By this means the statistics 
required can be clearly seen and the importance of obtaining 
them can be impressed upon all those responsible for their 
preparation. As the program proceeds it is possible to 
obtain statistics which will make possible such revisions as 
are found necessary. It is of course understood that if 
budgets are based on inadequate statistics, they must be 
used with much judgment. 

It is usually necessary, for the purpose of coordinating 
sales and production, or sales and purchasing, to make the 
sales budget and the production or purchasing budget in 
terms of items. In a business handling many thousands of 



86 



BUDGETARY CONTROL 



items this may be very difficult. It has been suggested 
previously that one method of attacking this problem is to 
select those items which represent the major part of the 
production and budget them. By gradually increasing the 
items selected for budgeting, an adequate system of budg- 
etary control can be developed. 

No method has ever been developed by which to fore- 
cast with exactness the future operations of a business. By 
careful study, plans can be made in most businesses which 
will correspond quite accurately with the results attained. 
Even in those businesses where it is possible to make plans 
which are only approximately correct, such plans are better 
than no plans at 'all. 

It has been the purpose of this chapter and the chapter 
immediately preceding, to explain some of the most impor- 
tant considerations governing the preparation and use of 
the sales budget. In the following chapters the preparation 
of the budgets of the other functional departments and the 
coordination of the sales budget with these will be explained 
and illustrated. 



• 



CHAPTER VII 
THE SELLING EXPENSE BUDGET 

Relation of Selling Expense to Sales 

It must be evident to the reader that though it is neces- 
sary to formulate a sales program, in some such manner as 
explained in the two chapters immediately preceding, such 
a program is lifeless considered by itself. Making a formal 
statement of the volume of sales desired, or of the class of 
sales desired, does not produce the sales. There must be a 
sales ''campaign" as well as a sales "program." 

A political party does not win an election by merely 
nominating candidates and preparing a platform. In addi- 
tion it must conduct a campaign to convince the public of 
the merits of its candidates and platform. In the same 
manner a business must conduct a sales campaign to con- 
vince the public of the merit of the product which according 
to its sales program it is offering for sale. 

A sales campaign may be said to consist of two mutual 
parts : 

1 . A knowledge of the sales desired and deemed possible. 

2. A plan for securing the results desired at the lowest possible cost. 

The sales desired and deemed possible are determined 
by the sales program and are expressed in the sales estimate. 
But this program cannot be formulated without considering 
the cost which it involves in the way of selling expense. 
There are few firms which could not increase their sales if 
they desired to incur the necessary expense. Sales are de- 
sired only when profits will result. The probable profits 
should be determined before an attempt is made to secure 
the sales. In determining the probable profits, the selling 

87 



88 BUDGETARY CONTROL 

cost which the sales program will involve must be given 
careful consideration. It is obviously impossible for the 
budget committee or the board of directors to judge the de- 
sirability of the contemplated sales program as presented 
by the sales department unless they know the cost of this 
program. 

Need for Estimate of Selling Expense 

The selling expense estimate is needed for the following 
purposes : 

1. That the sales department may be able to judge the desirability 

of its contemplated sales program. Without a knowledge of 
its probable cost it is unable to prepare and present for execu- 
tive consideration an acceptable program. 

2. That the sales department may have a basis for planning its sales 

campaign. It must know the funds which are available before 
it can enter into contracts for services or engage personnel. 

3. That the treasurer may know the probable disbursements re- 

quired by the sales program and can plan to obtain the funds 
necessary to meet these disbursements. 

4. That the budget committee may be able to see the financial re- 

quirements of the proposed sales and production programs at 
the time they are submitted to it for consideration. The sell- 
ing expense in many cases constitutes one of the major items 
which appear on the disbursement side of the financial budget. 

Importance of Sales Expense Control 

It is highly important that an effective control be exer- 
cised over sales expense if the greatest amount of profit is to 
be derived from the sales operations. Unless that is done, 
this type of expense is apt to increase unduly. 

The services obtained from the expenditures of the sales 
department are in the main of an intangible nature and 
therefore difficult to appraise. For instance, it is usually 
difficult to determine accurately the benefit obtained from 
expenditures incurred for advertising, and the same is true 



THE SELLING EXPENSE BUDGET 89 

to a considerable degree of expenditures for the services of 
salesmen. There are some direct results which can be 
traced, but in many cases the major results are so indirect 
that they cannot be connected directly with the ex- 
penditure. 

If a purchase of materials is made for the production 
department, it is possible to connect directly the materials 
received with the funds expended. It is possible to judge 
the wisdom of the expenditure by determining the value of 
the materials. But if space for advertising is purchased, it 
is usually not possible to determine the number of orders 
which result from the expenditure. It is also difficult to 
determine for how long benefit may be derived from the 
advertising. Orders may be received as a result of the 
advertising some time after the expenditure for it is in- 
curred. Again, a salesman may build up good-will for his 
company which will result in orders after his services are 
ended. Because of this indefinite relation between cause 
and effect, executives are apt to think that the sales expense 
is necessary and should be incurred even though direct 
results cannot be seen, and therefore they may not scruti- 
nize closely the amount and nature of this expense. 

Moreover, hardly any satisfactory standards exist by 
which to judge selling expense. It is possible to determine 
the amount of material necessary to produce a certain arti- 
cle, and use this amount as a standard to judge the future 
consumption of materials in the production of that article. 
But there is no exact means of determining the amount of 
selling expense which is necessary to secure a dollar of sales, 
and it is therefore more difficult to formulate a standard by 
which to judge the quantity of selling expense. 

Because of these reasons it is especially necessary that 
formal and exact control of selling expense be exercised. 
This control involves three steps: 



90 BUDGETARY CONTROL 

1. Determination of what is included in selling expense and the 

setting up of a proper classification thereof. 

2. Determination of standards by which to judge the amount of 

selling expense, and the use of these standards in the formula- 
tion of a selling expense budget. 

3. Determination of methods of enforcing the standards set, and the 

execution of these methods. 

Definition of Selling Expense 

There is a considerable difference of opinion among both 
accountants and business men as to what should be consid- 
ered as selling expense. This is probably due to several 
causes. 

There are many items of expense which contribute more 
or less indirectly to the making of sales. Inasmuch as sales 
consummate the process which results in the securing of a 
profit, it is not difficult to reason that the purpose of many of 
the operations of the business is to secure sales and that the 
expense incurred in those operations should be treated as a 
selling expense. 

The classification of expenses is discussed at some length 
in Chapter XVIII of this book in connection with the con- 
sideration of the expense budgets, and it is not desired to 
enter into this subject here. Suffice it to say that from the 
viewpoint of administrative control it is desirable that 
expenses should be classified so as to indicate the responsi- 
bility for their incurrence. Executive control can be exer- 
cised only in terms of organization, and members of an 
organization can rightly be held responsible only for that 
over which they exercise control. 

If responsibility is taken as the controlling factor in an 
expense classification, selling expense will include all ex- 
penses which are under the control of the sales manager or 
executive head of the sales department, and in addition such 
miscellaneous items as are directly connected with sales and 



THE SELLING EXPENSE BUDGET 9I 

the amount of which is fixed or at least beyond the direct 
control of any officer. 

An illustration of the former case is found in the salaries 
of employees in the sales department, who are under the 
direct control of the sales manager, while an illustration of 
the latter case is found in depreciation on delivery equip- 
ment, the estimated amount of which is usually determined 
by others than the sales manager. The depreciation may 
properly be treated as a sales expense, for it is connected 
directly with the sales function. Its amount, raoreover, 
could not be affected by the action of the sales manager 
even if the determination of it were in his power, since it is 
assumed that the correct amount is to be stated. 

These illustrations should be sufficient to enable the 
reader to determine the proper treatment of other items 
about which there may be a question. There are some few 
items the classification of which is dependent on a decision 
as to the purpose for which they are incurred, and in many 
instances there is no unanimity of opinion with reference to 
this purpose. These items will be discussed in Chapter 
XVIII on expense budgets. 

Classification of Selling Expense 

It is customary to charge as a part of the cost of goods 
sold, all expenditures incurred in connection with the product 
up to the time when it is ready to be offered for sale. This is 
based on the theory that the sales department does not have 
jurisdiction of the merchandise prior to this time and is not 
responsible for the expenditures incurred in connection with 
it. The first expense incurred by the sales department is in 
the securing of sales orders. This expense will include the 
expenses of the sales office which directs the sales effort, the 
salaries of salesmen, and the expenses of salesmen. It may 
also include the cost of advertising. After the goods are 



92 



BUDGETARY CONTROL 



sold they must be prepared for delivery to the customer — 
which involves packing or wrapping, and finally they must 
be delivered to the customer, or to a transportation com- 
pany which will effect the delivery. On the basis of the 
foregoing discussion it is possible to set up the following 
classification of sales expense: 

1. Sales office expense 

2. Salesmen's salaries and expenses 

3. Packing and shipping 

4. Advertising 

The first three of these items will be discussed in the 
present chapter. The control of advertising expense is 
thought of sufficient importance to merit separate treatment 
and its discussion will be postponed until the next chapter. 

Sales Office Expense 

Sales must always be subject to some executive super- 
vision and this supervision results in expense. The nature 
of the supervision exercised over sales will depend upon the 
size and organization of each particular business. In most 
businesses there is a sales manager who is the executive head 
of the sales department, and frequently he is assisted by a 
staff. In many cases there are district offices each under 
the control of a manager who is subordinate to the general 
sales manager. Each district manager may have a staff 
of assistants. If a company has a sufficient volume of 
foreign sales, it may have an "export" sales office in the 
charge of a manager with the appropriate assistants. In a 
company distributing its product through branches, there 
is a sales staff at each branch. 

As the sales organization grows, care must be exercised 
to avoid incurring unnecessary expense. It is but natural 
that each subordinate office will desire to enlarge its activi- 
ties as much as possible and because of this tendency there 



THE SELLING EXPENSE BUDGET 93 

may be a duplication of work. There are many activities 
which can be performed better by the central sales office for 
the benefit of all the subordinate offices than by each office 
for itself. Every professional man who has done work on 
administrative control can recall instances of duplication of 
work in branch offices which existed because it had not 
been called to the attention of the general officers responsi- 
ble for the control of branch expense. 

The preparation of estimates of sales expense will do 
much to prevent incurring unnecessary expense by units of 
sales organization. These estimates will serve, in the first 
place, to call the attention of all the executives of the com- 
pany to the expenses of each unit and to require them to 
consider these expenses before they are incurred, and in the 
second place, to provide comparison between different units. 
It should be apparent, if the estimate of selling expenses of 
the X unit calls for expenditures which are equal to lo per 
cent of estimated sales, and the estimate of the Y unit calls 
for expenditures which are equal to 20 per cent of estimated 
sales, that the budget committee will call for an explanation. 
In fact the sales manager should have asked for an explana- 
tion before he transmitted the estimates to the executive 
in charge of the budget committee, and the latter should 
call the attention of the budget committee to the fact and 
to the explanation of the sales manager which it is assumed 
he attaches to the estimates when he transmits them. 

Salesmen's Salaries and Expense 

There is usually little difficulty in deciding as to the items 
which should be included under this heading or as to the 
proper method of recording and reporting them. The chief 
problem is the controlling of such expenses, for they have 
a tendency to become unduly large unless an effective check 
is exercised. One of the chief sources of difficulty is the 



94 BUDGETARY CONTROL 

determination of the proper method of compensating the 
salesmen for their services. 

If definite salaries are paid salesmen, it is often difficult 
to determine the equitableness of the amount paid. In an 
attempt to lessen the difficulty, salesmen may be paid in 
whole or in part on a commission basis. Some sales execu- 
tives think that a salary plus a commission is the most de- 
sirable method on the theory that the work of a salesman 
cannot be judged entirely by the sales which are directly 
attributable to him. He may have a certain advertising 
value to the business which is not adequately measured in 
terms of the sales orders which he turns in. A salary, which 
is not directly dependent on the volume of sales, remunerates 
him for the work which he does towards building up the 
good-will of the firm; whereas the commission which he 
receives, based on the volume of sales secured or on the 
excess of sales over a certain amount, rewards efficiency and 
penalizes inefficiency. Those who are exponents of the pay- 
ment of a commission only contend that the salesman is 
remunerated for the work he does in building up good-will 
by the additional orders which he will receive later on. If 
all orders received from the salesman's territory are credited 
to him, there is merit in this contention. 

The method to be employed in reraunerating the sales- 
men is a problem of the sales department, but as it has an 
important bearing on the preparation of the estimate of 
selling expense, it is of interest to the student of budgetary 
control. It may be added that, if a proper control is to be 
exercised over these expenses, it is necessary to have records 
and reports which will provide an analysis of sales and sell- 
ing expense showing: 

1. Whether the salesman or the territory is responsible for the sales. 

2. Whether the sales which are being made are of the goods which 

the company most desires to sell. The latter, at least, can be 



1 



THE SELLING EXPENSE BUDGET 95 

determined by obtaining the profit realized on sales made by 
each salesman and judging his efficiency in terms of profit 
rather than by volume of sales. 

The nature of the reports used in exercising control of 
salesmen's expenses will be discussed later in this chapter. 

Packing and Shipping 

The araount of the expenses incurred in packing and 
shipping merchandise depends upon the nature of the prod- 
uct sold and to a considerable degree upon whether a firm is 
doing a retail, wholesale, or manufacturing business. In a 
retail business the merchandise in most cases is wrapped by 
the salesmen, or by clerks who are located in each depart- 
ment for that purpose. It may be delivered to the cus- 
tomer by the sales clerk at the time of sale or by the regular 
delivery service of the business. In a wholesale and manu- 
facturing business there is usually a separate shipping de- 
partment which is responsible for the packing of the mer- 
chandise and its delivery to the transportation company. 
In a few companies freight is paid on all goods shipped, in 
which case we have the item of "freight out." 

The shipping department is not always under the control 
of the sales department. In a manufacturing business it 
may be under the control of the production department. 
In a department store it may be under the control of the 
operating superintendent. If the shipping department is 
not under the control of the sales department, the latter 
cannot be held responsible for the shipping expense. But 
the estimate of shipping expense must be considered with 
the sales program, since it varies with the volume of sales. 

Some Packing Cost a Manufacturing Expense 

Not all the expenses of packing, or at least of placing 
merchandise in containers, are to be treated as selling ex- 



BUDGETARY CONTROL 

pense. If the packing is that which goes directly on goods 
and is necessary to preserve them and to keep them in a con- 
dition to be sold, the charge is against the cost of the goods. 
Examples of such cases are the jars which hold fruit, the 
boxes containing cigars, the paper wrappers on chocolate 
bars, etc. Such containers or wrappers are an integral part 
of manufacturing costs and should be so treated in the 
accounts and the reports. If the wrappers contain adver- 
tising matter, some part of their cost may be charged to 
advertising expense. 



Allocation of **Drayage" Expense 

The expense of packing goods for shipment may ordi- 
narily be treated as a selling expense, as may also the ex- 
pense of carrying the goods to transportation agencies for 
shipment. Sometimes the same employees are used in con- 
nection with the unpacking of goods when received and in 
packing them for shipment after they are sold. In such 
cases the expenses incurred in connection with both opera- 
tions are usually charged to one account and then allocated 
as between cost of goods and selling expense. In many 
cases the same transportation equipment, such as trucks or 
horses and wagons, are used to transport incoming and out- 
going goods. In such cases the total expense is usually 
charged to a '' drayage " account and later allocated on some 
equitable basis, such as the ratio of cost of purchases to 
cost of goods sold. In some cases the tonnage transported 
to and from the station may be available and can be used 
as the basis of allocation. 



Treatment of Freight Out 

There is some difference of opinion as to the treatment of 
the expense incurred in shipping goods to customers if the 
transportation charges are paid by the vendor. It is some- 



1 



THE SELLING EXPENSE BUDGET 97 

times argued that such expenses, which are usually termed 
"freight out," should be deducted from gross sales, since 
"freight in" is added to purchases in determining the cost 
of goods sold. Such a procedure seems logical and if trans- 
portation charges are paid by the vendor on all the goods 
sold, or on the major part of them there is little objection to 
this treatment since it must be assumed that the matter was 
considered in setting the sales price and a sufficient amount 
added to cover the anticipated cost of shipment. If, as is 
usually true, the vendor pays these charges only in excep- 
tional cases to obtain special orders, it would seem more 
proper to treat them as selling expense. In these cases the 
granting of such concessions is under the control of the sales 
department and allowed only when this department thinks 
it is advantageous to do so in carrying out its sales program. 
Unless the sales department is charged with these expenses, 
it is apt to be too lenient in granting such concessions, and 
moreover the comparison of selling expense with sales, 
period by period, will not show exact results. 

Analysis of Shipping Expenses 

As a matter of control it is often advisable to subdivide 
packing and shipping expenses. A geographical analysis 
will often prove useful. When uniform prices are quoted 
regardless of territory, an analysis of packing and shipping 
expense on a territorial basis will often show that some 
goods are being sold at a very small profit or even at a loss, 
because of the additional expenses incurred in connection 
with their preparation for shipment and delivery. This is 
apt to be true particularly when a manufacturer of bulky 
articles has a national market. One writer even goes so far 
as to say: "I have never seen such a division made by a 
national manufacturer, selling from coast to coast, which did 
not show that in some sections he was selling merely to help 



98 BUDGETARY CONTROL 



d 



his pride and not his profit; in distant markets, the extra 
packing and the high freight outward will commonly be 
found to absorb the entire normal profits." 

Use of Warehouses and Branch Depots 

Whenever possible, sales should be made f.o.b. the 
place of manufacture. If because of the custom of the 
trade the freight must be paid by the vendor, then a business 
may find it profitable to establish branch depots or ware- 
houses to which goods may be shipped in bulk and then dis- 
tributed. Many national manufacturers have such ware- 
houses. Some department stores in large cities establish 
warehouses in different parts of the city, from which they 
deliver goods to customers. Where warehouses exist it is 
necessary to give careful consideration to their cost in pre- 
paring the expense estimates. 

Treatment of Breakage ^H 

Another item of considerable importance in some cases 
is the loss arising as a result of breakage or damage occurring 
in the process of shipping. If there is a regular, unavoidable 
breakage it can properly be treated as sales expense. If 
there is a breakage in connection with one line which is not 
common to all lines handled, it is better to raise the sales 
price of this commodity sufficiently to cover the breakage 
and not attempt to allocate it over all goods sold. 

Importance of Proper Handling of Packing and Shipping Expenses 
The matter of packing and shipping expense has here 
been given considerable space, for it has been the author's 
experience that in many cases definite responsibility is not 
fixed for the administration of the shipping department and 
consequently effective control of shipping expense is not 
exercised. The preparation and enforcement of careful 
estimates will aid in remedying this condition. 



THE SELLING EXPENSE BUDGET 99 

Method of Estimating Selling Expense 

One of the most useful devices a manager can have is 
that of expense standards. If he knows what is current 
practice in various fields of expenditure, he has a sort of 
norm against which to measure his own performances and 
with which to check his own figures in the preparation of 
budgets. Such standards are needed in controlling the oper- 
ations of all the functional departments, but are particularly 
needed by the sales manager because of the nature of sales 
expense and its indefinite relation to results. 

Unfortunately, not much has been done towards de- 
veloping standard rates for selling expenses. Some few 
agencies, like the Bureau of Business Research of Harvard 
University, have gathered data which show the prevailing 
rates in certain lines of industry. These statistics are use- 
ful in enabling the executive to see how his business com- 
pares with others in the matter of selling cost. Certain 
trade associations, moreover, have gathered data with refer- 
ence to the expenses of their members and made it available 
for the use of other members. In the past many firms have 
hesitated to give their competitors data with reference to 
expenses and costs. This attitude is changing to a con- 
siderable degree and we can expect that more and more 
there will be available useful data of this nature. 

Even though data are obtainable which show the selling 
expenses of other firms, there is no assurance that the rates 
thus shown are desirable. Each firm must of necessity 
develop its own rates and determine the standards which are 
applicable to its conditions. If periodical estimates, based 
on scientific research, are carefully made and these estimates 
are controlled by accurate reports, a firm will gradually 
develop standards which will be very useful in making plans 
and judging results. Until such standards are available it 
must use the best data obtainable in preparing its estimates. 



lOO BUDGETARY CONTROL 

In preparing the estimate of selling expense It Is neces- 
sary to consider each class of expense separately. If the 
sales office expense has been satisfactory in the past, the 
amount shown by the past records may be used as a basis 
for the current estimate, of course considering separately 
each Item of expense. Consideration must be given to 
salaries of the sales manager and his staff, salaries of clerical 
assistants and stenographers, cost of supplies, etc. In case 
of district or branch offices It will be necessary to make a 
separate estimate for each item of expense to be incurred in 
these offices. It should be evident that in no case should 
the sales office expense be estimated on a percentage basis. 
As sales increase, the ratio of "overhead" expenses to 
sales should decrease. If the sales office expenses are 3 
per cent of sales when the yearly sales are $100,000, they 
should be expected to be something less than 3 per cent 
when sales become $500,000. 

If salesmen are paid a commission they usually pay their 
own expenses, and it is consequently very easy to estimate 
the cost of salesmen's expenses and salaries. The rate of 
commission is applied to the estimate of sales, and the result 
Is the estimate of salesmen's salaries and expenses. If the 
salesmen are paid a salary and the company pays their ex- 
penses, it is necessary to consider each salesman individu- 
ally. After a list of all salesmen is made, there will be 
placed after the name of each his present salary and the 
normal amount of his expenses. This list will be gone over 
by the sales manager and his assistants. If advances of 
salesmen's salaries are contemplated, these will be shown. 
Each salesman's expenses will be examined and revisions 
made when it is thought that conditions warrant. Gradu- 
ally standard expense rates should be developed for each 
territory and the salesmen's expenses based on these stand- 
ards. If the rates are fairly determined, each salesman can 



THE SELLING EXPENSE BUDGET lOI 

be required to limit his expenses so that they will not exceed 
the standard. 

If possible, standards showing the cost per unit for 
packing and shipping should be developed. If this is not 
feasible because of the variety of units sold, it is then neces- 
sary to develop a standard rate expressed in terms of a per- 
centage of sales. In either case it should be kept in mind 
that as the volume of sales increases, the ratio of packing 
and shipping expense should decrease. Under normal con- 
ditions such a result is to be expected because there are cer- 
tain items of overhead which will not increase in proportion 
to volume of goods handled. 

After standard rates for packing and shipping expense 
are developed, it is only necessary to apply these rates to the 
sales volume as shown by the sales estimate to obtain the 
amount of the estimated packing and shipping expense. If 
there are conditions which indicate a deviation from the 
standard rates, these must be given consideration. 

Preparation of Selling Expense Budget 

The sales office expense estimate will be prepared by the 
staff of the executive head of the office. If there be but one 
sales office, the estimate will be prepared by the staff of the 
sales manager. If there are branch or division offices, the 
staff of each office will prepare an estimate of that office, 
and after it is approved by the manager it will be forwarded 
to the sales manager at the general office. 

The salesmen's salaries and expense estimate should be 
prepared by the immediate superior of the salesmen for 
whom the estimate is made. If there are branch and divi- 
sion offices, each of these will prepare an estimate for the 
salesmen belonging to that office, and after it is approved by 
the manager it will be forwarded to the sales manager at the 
general office. 



102 BUDGETARY CONTROL 

The packing and shipping expense budget will be pre- 
pared by the head of the shipping department and forwarded 
by him to the sales manager. 

The sales manager will make such revisions as he thinks 
necessary in the estimates of his subordinates and forward 
them to the executive in charge of the budget procedure, 
with such recommendations as he may desire to offer. The 
executive in charge of the budget procedure will forward 
these to the budget committee, which will make any re- 
visions which it may think necessary and return the esti- 
mate with its approval to the executive in charge of the 
budget procedure. The latter will return them to the sales 
manager, who in turn will transmit to each subordinate his 
budget as approved. 

In form the estimate of selling expense may be made as 
shown in Figure 3. The purpose of each of the columns 
shown on this form should be apparent to the reader. 

In some businesses the controller prepares all expense 
estimates, including those for sales expense. Although the 
controller may very properly be given the authority to pre- 
scribe the form of the estimates and the reports to be used in 
their control, it is the author's opinion that he should not 
be responsible for their preparation. The reasons for this 
belief have been explained in Chapter III and need not be 
repeated here. As a member of the budget committee the 
controller will have an opportunity to pass upon all budgets 
submitted and should be able to offer constructive criticism 
of them. In some cases it may be desirable to refer the 
estimates to his office for review before they are considered 
by the budget committee. 

Control of the Selling Expense Budget 

To exercise control of the selling expense budget, it is 
necessary to have a proper system of reports which will make 



THE SELLING EXPENSE BUDGET 



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104 BUDGETARY CONTROL 

possible a proper check of its operation. These reports may 
be divided broadly into two classes : 

1 . Those which are used by the sales department in the enforcement 

of its budget. 

2. Those used by the executives and the budget committee to judge 

how well the sales department has succeeded in the enforce- 
ment of its budget. 

The first class of reports may be well illustrated by those 
required in enforcing the salesmen's expense budget. The 
reports used for this purpose may in turn be divided broadly 
into two classes: 

(a) Those which are used primarily by the general sales office. 

(b) Those which are used primarily as reports to salesmen. 

For the use of the general office it is useful to make a 
report showing for each salesman the following compar- 
isons : 

(a) Actual sales and estimated sales 

(b) Expense and sales 

(c) Actual expense and standard 

(d) Expense with average of territory 

If in addition to the amounts these comparisons are ex- 
pressed in percentages, the report is much more useful. If 
this report shows wide variations between the standard 
and the actual, supplementary reports should be prepared 
explaining the variations. 

Reports may be sent to the salesmen monthly, or even 
weekly if desired, showing a comparison between the esti- 
mated expense and the actual and also the profit earned by 
their sales. In some cases the gross profits by lines may be 
shown on these reports, so as to indicate to the salesmen the 
lines of merchandise which they should push. 

For the use of the general executives and the budget 
committee a report may be made in the form of Figure 4. 



I 

i 



THE SELLING EXPENSE BUDGET 105 

The purpose and value of each of the columns shown on 
this report should be apparent to the reader. In case this 
report shows wide variations between the actual and the 
estimated, supplementary reports should be submitted 
explaining the variations. 



CHAPTER VIII 



THE ADVERTISING BUDGET 



Relation of Advertising to Selling Expense 

There has long been an argument among the executives 
in the marketing field as to the relation of advertising and 
selling — principally as to the proper relation between 
the advertising manager and the sales manager. Some 
have contended that the advertising manager should be the 
executive head of an independent department, while others 
have insisted that he should be subordinate to the sales 
manager. There is no intention of entering into this dis- 
cussion here, but it is desired to emphasize that regardless of 
the organization by which the advertising is carried on, the 
advertising program must be considered as a part of the sales 
program as a whole and the advertising expense must be 
considered as a part of selling expense. 

It should not be difficult for the reader to see why this 
is true. The purpose of the advertising and of the sales 
force is the same — to secure the maximum of profitable sales 
with a minimum of cost. There are some services in the 
marketing of a product which commonly can be performed 
more effectively by advertising than by the sales force, and 
the opposite is equally true. The advertising campaign 
must be planned with reference to the specific work which 
it is expected to perform in relation to the other sales work j 
of the company. Consequently, neither the amount of the { 
advertising expense nor the amount of the other items of i 
selling expense can be determined independently. The | 
advertising budget must be presented as a part of the larger j 
selling expense budget. \ 

1 06 



THE ADVERTISING BUDGET 107 

The Advertising Appropriation 

It has long been the practice of many firms to make an 
annual ''appropriation" for advertising expense. It may 
seem strange that a firm will make an advertising appro- 
priation but will not make an appropriation for any other 
purpose. We rarely hear of an accounting appropriation, 
a manufacturing appropriation, a traffic appropriation, etc. 
It may at first be thought, since definite appropriations are 
made for advertising expense, that this class of expense is 
more effectively and scientifically controlled than are the 
expenses of the various other departments. Further study 
will lead one to doubt if this be true. Rather one is apt to 
find that the practice of establishing definite appropriations 
for advertising expense is based upon two reasons : 

1. Outside counsel, in the form of advertising agencies, have often 

been employed to direct the advertising and it was necessary 
to have a definite agreement with them with reference to the 
amount which they were permitted to spend. 

2. Business executives have not regarded advertising expense as 

they have the other expenses of the business, but rather as an. 
additional expense which while it might be beneficial was not 
necessary for survival. As they knew no definite way of deter- 
mining the amount of the advertising expense, they guessed at 
a lump sum which they thought they could afford, and took a 
chance on obtaining results from it. In many cases it was a 
policy of cast your bread on the waters and trust it to return. 

The professional advertising agency has rendered a 
service by teaching business executives the necessity for 
formulating an advertising program and coordinating this 
program with the sales program. It is but natural, how- 
ever, for these specialists to be enthusiasts for advertising 
and it is open to question whether they have always given as. 
much attention to scientific methods of calculating the 
amount of the advertising appropriation as they have to the 
attempt to make it as large as possible. In many cases this 



J 



I08 BUDGETARY CONTROL 



proved a short-sighted policy because it produced a reaction 
when the management failed to see adequate returns for 
the money expended. This remark is not intended as a 
criticism of advertising agencies, for many of them have 
rendered very useful service in advising executives with 
reference to the amount of the advertising which they should 
do, as well as the kind of advertising which would be most 
effective. Their errors have probably not been greater or 
more numerous than those of the professional accountant or 
the engineer. 

Methods of Calculating Advertising Cost 

In recent years both advertising experts and business 
executives have come to realize, first, that advertising ex- 
pense is a necessary expense of operation, no less than the 
expense incurred in carrying on any of the other functional 
activities of the business ; second, that the advertising pro- 
gram is closely related to the program of the business as a 
whole and that therefore the amount of the advertising 
expense should be based on contemplated plans of the busi- 
ness as a whole. As a result considerable attention has been 
given to the proper method of calculating advertising ex- 
pense. The following methods are those in most current use : 

1 . The advertising expense of the current period may be 
based on the expense of the previous period, adding or sub- 
tracting a certain percentage depending on the opinion of 
the executives with reference to the success of the advertis- 
ing program of the preceding period. The general manager 
may say to the advertising manager, ''Last year we spent 
$110,000 for advertising expenses; this year you may spend 
5 per cent more." Such a budget refers the advertising 
manager to the expense accounts of the preceding year for 
his working program. 

2, The advertising expense of the current period may 



THE ADVERTISING BUDGET 109 

be based on the estimated sales of the current period, deter- 
mining the amount by taking a certain percentage of the 
total volume of sales. For instance, the general manager 
may say to the advertising manager, ' ' Last year we spent 
5 per cent of sales for advertising expense. Here is our 
sales expectancy for this year. We expect you to secure the 
sales at an advertising cost of 5 per cent or less." This 
method is more scientific than that suggested in (i) for it 
requires the advertising manager to connect cause with 
effect — advertising expense with sales to be secured. It 
should be apparent that the advertising expense should not 
be based on past sales. The advertising of the current 
period can have no effect on, or no relation to, the sales of 
past periods. It is to make possible the attainment of the 
current sales program that the advertising program is in- 
tended, and the amount to be expended under the adver- 
tising program can only be determined properly by con- 
sidering the current sales program. 

3. The advertising expense of the current period may be 
based on the estimated sales of the current period, deter- 
mining the amount by allowing for advertising so much per 
unit of the product which it is planned to sell. For instance, 
it may be agreed that so many cents will be spent for adver- 
tising for each crate, ton, dozen — or other unit used in the 
estimate — which is expected to be sold. 

Readers interested in other methods of calculating ad- 
vertising cost may well read articles by John A. Murphy, 
in December 9, 1920 and December 16, 1920 issues of 
Printers' Ink. 

Advantages and Disadvantages 

Opinion differs with reference to the merits of these dif- 
ferent methods. No definite rule can be laid down to 
govern the policy to be followed by all businesses. In the 



no BUDGETARY CONTROL 

Opinion of the author the first method is the one least to b( 
desired. It is apt to result in careless planning of adver-^ 
tising cost, since it is so very easy to add or subtract a cer- 
tain percentage of past expenses and not to consider the 
question further. It is also apt to result in basing present 
expenses on past expenses without giving proper considera- 
tion to the contemplated changes in the sales program. At 
least it fails to compel a consideration of present plans. 
The ideal in the designing of methods of administrative 
control is to secure those which will compel coordination 
and at the same time promote progress. 

To base the advertising appropriation on a percentage of 
the volume of sales tends to simplicity, and in a business 
where the fluctuation in sales is not great may give satis- 
factory results. This condition is more apt to prevail in a 
business handling a staple and well-established line than in 
a business handling specialties. In a business having many 
and varied lines it may be the only feasible method, since 
calculation of the unit cost of advertising for each item of 
goods sold may not be practicable. This method has the 
disadvantage of fluctuating unduly in some cases because of 
the fluctuation in the price of purchases of materials, sup- 
plies, and labor, and consequent fluctuation of the selling 
price. In a period of depression as many units of commodity 
may be sold as before the depression, but at a price which 
will greatly decrease the total sales in terms of dollars and 
cents. In this case if the advertising appropriation is based 
on the sales volume expressed in terms of dollars and cents, 
it will be greatly decreased, whereas it may be desirable to 
keep up the advertising campaign in order to maintain the 
sales volume in spite of the adverse conditions. There is 
something to be said for the possibility that if the sales price 
of the commodities sold has decreased, the cost of advertis- 
ing will decrease also. 

If advertising is calculated as so much per unit of product 



THE ADVERTISING BUDGET III 

sold, it tends to concentrate attention on the purpose for 
which the advertising is incurred and incidentally to call 
attention to the unit cost and unit profit realized on the 
articles sold. This method is also apt to cause the advertis- 
ing appropriation to fluctuate less, since the units sold are 
apt to vary less than the returns from sales. There may 
be some argument for having the advertising fluctuate as the 
sales fluctuate. At least there are occasions when this is 
true. There are also other occasions where the advertising 
may fluctuate in reverse order to the fluctuations in sales. 
A financially strong enterprise may increase its advertising 
during a period of depression in order to reduce the decrease 
in sales to a minimum and to establish itself in the market 
so as to take advantage of the contemplated period of pros- 
perity. 

It would seem, regardless of whether the unit costs or 
the percentage method is used, that revisions will have to be 
made in case of changing conditions which affect the general 
plans made at the time the advertising appropriation is 
determined. The advertising appropriation should be re- 
garded as only an estimate and subject to revision no less 
than the other estimates. Of course, in making such re- 
visions outstanding commitments must be considered. 

There is reason to believe that advertising managers 
have placed great emphasis on the basis of determining the 
amount of the advertising appropriation, because it has 
been difficult to get appropriations approved and conse- 
quently it was desirable to get a definite basis established 
which would give them the maximum amount under all cir- 
cumstances. 

Regardless of the basis adopted for calculating the ad- 
vertising appropriation, each individual business must make 
constant study of its advertising program with the object 
of revising it as soon as the necessity is indicated. 



112 BUDGETARY CONTROL 

Determining the Amount of the Advertising Appropriation ^ 

After the basis on which the advertising appropriation is 
to be calculated is decided, it is necessary to determine the 
desired amount in dollars and cents. Theoretically the 
rate may be determined without consideration of the total, 
but it is doubtful if this is ever done. A firm may decide 
that it can well afford to spend one cent per article sold for 
advertising, but if the total thus determined runs beyond 
the amount necessary to pay for the advertising plans con- 
templated, the rate per unit will be reduced. If a percent- 
age of sales is used as the basis the same procedure will be 
followed. After the total is determined the rate will be 
revised, if necessary, to make the total somewhat near the 
amount which the executives think desirable. 

In determining the amount of the appropriation two 
important factors must be given consideration : 

1. What is the purpose of the advertising — what is to be accom- 

plished by it? 

2. How is the advertising appropriation to be expended — how is the 

purpose of the advertising to be accomplished? 

Purpose of Advertising 

If we assume that a business has previously done no 
advertising, the selling price of its commodity will be com- 
posed of the following items: manufacturing or purchase 
cost, selling expense, administrative expense, and profit. 
Expressed in the form of an equation we have : 

Cost of goods sold + selling expense + administrative expense 
-l-profit = selling price 

Obviously, if it is determined to incur expenditures for ad- 
vertising, some of the members of this equation will be 
changed. Either the left-hand members must be decreased, ! 
or the right-hand member must be increased. ^ 



THE ADVERTISING BUDGET II3 

The competitive condition of the market may be such 
that by the advertising a sufficient demand can be created 
for the product to make possible an increase in the selHng 
price. If this be true, the cost of the advertising may be 
consumed by the increase in selHng price and the other 
members of the equation left undisturbed. This condition 
is not apt to exist in many cases under present competitive 
conditions. In fact, only in the case of a monopoly can 
such a result be expected to be obtained permanently. 

If the purpose of the advertising is to maintain the pres- 
ent volume of sales during a period of bitter competition, 
the expense raay be met out of profits. The company may 
desire to maintain its position in the trade even though 
smaller profits are to be secured at the present time. It 
may be thought that the lessened profits at this time will be 
more than compensated for by increased profits in the future. 
Similarly a company may incur advertising in order to ward 
off hostile public opinion and to prevent undesirable legis- 
lation. Public utilities have done considerable advertising 
of this nature during past years. More recently some of 
the packing companies have followed the same practice. 
Advertising of this nature may well be met out of profits 
because it is thought that it will prevent lessened profits in 
the future. Again, a firm may incur expenditures for adver- 
tising which will lessen current profits but build up good- 
will which in turn will result in larger future profits. 

In some cases advertising is incurred because it is thought 
that it will increase the volume of sales and thus result in a 
decrease of the cost of goods sold, the selling expense, or the 
administrative expense. 

In a manufacturing business, an increase in the volume 
of sales, with the consequent increase in the volume of pro- 
duction, will usually decrease the cost of production because 
of the decrease in the unit cost of overhead. It may also 



114 BUDGETARY CONTROL 

make possible a more economical use of labor and materials. 
For instance, the production may become of sufficient vol- 
ume to make possible the use of scrap in the production of a 
by-product. In a mercantile business the increased volume 
of sales may make possible more economical purchasing 
with a lower unit cost for goods purchased, but the savings 
in this connection are rarely comparable with the decrease 
in the unit cost of goods manufactured when the volume of 
production is increased. 

The increased volume of sales may reduce the unit sell- 
ing cost. If the advertising enables each salesman to sell 
more with the same amount of effort and expense, the unit 
selling cost will be decreased accordingly. In addition to 
the cost of salesmen, the overhead expense incurred in main- 
taining the sales manager and his staff is usually an appre- 
ciable amount, and an increase of sales will not usually 
cause this expense to increase in proportion. 

Finally, an increase in volume of sales should have a de- 
sirable result on the administrative expense. There is every 
reason why the ratio of administrative expense to sales 
should decrease as the volume of sales increases. 

Importance of Defining Purpose in Advance 

The foregoing discussion shows that there may be sev- 
eral reasons why advertising should be undertaken. The 
primary purpose of pointing out these various purposes is to 
emphasize that the results which it is expected to obtain as 
a result of the advertising should be clearly in mind before 
the advertising is begun. So far as possible, data should be 
prepared to show the possible results of the advertising. 
The most difficult problem is that of determining the 
effect of the advertising on the volume of sales. If this 
can be forecast it is usually possible to estimate the 
approximate effect of the advertising on the manufactur- 



THE ADVERTISING BUDGET II5 

ing cost, selling expense, administrative expense, and net 
profit. 

Unfortunately, some firms make advertising appropria- 
tions expecting to obtain a large increase in volume of sales, 
without stopping to determine whether the increase in vol- 
ume which is anticipated would produce satisfactory results 
— that is, whether the savings resulting from the increase 
will be equal to the cost of the advertising. Only recently 
a manufacturing firm entered into a large contract for ad- 
vertising and the president showed the author the estimated 
increase in sales which he expected to obtain as a result of 
this advertising. A few moments' calculation showed that 
if the anticipated volume of sales was obtained the factories 
of the company would not be able to produce goods to 
satisfy 75 per cent of the sales orders. In this case, regard- 
less of whether the advertising failed or succeeded so far 
as producing the contemplated volume of sales, the firm 
was bound to lose as a result of the contract. This is but 
another instance of lacjc of coordination, which a proper 
program of budgetary control would rectify. 

All of which is to say that advertising is merely a means 
and not an end in itself. It is a potent force in modern 
management but it produces satisfactory results only when 
it is used with judgment and is coordinated with the other 
functional activities of a business. 

Method of Accomplishing Desired Purpose 

After deciding that it is desirable to use advertising for 
some particular purpose, it is necessary to determine the 
most effective way of accomplishing this purpose. It is not 
enough to decide that there are many people who need and 
can afford the product which you sell and that you can 
profitably spend a certain amount in order to get them to 
purchase a certain volume. It is also necessary to decide 



Il6 BUDGETARY CONTROL 

in what way they can be reached so as to persuade them to 
purchase. In other words, it is necessary to decide upon 
the medium of advertising to be used. 

There is a multipHcity of ways in which advertising may 
be accompHshed. To the layman the various possibiHties 
present a confusing complexity. Because of this very com- 
plexity it is necessary that very careful consideration be 
given to the contemplated program. Although the adver- 
tising department should be given considerable freedom of 
judgment, this freedom should be manifested in the main 
before, instead of after, the advertising appropriation is 
approved. It does not seem desirable that the department 
be given a lump sum without any conditions being attached 
to its use. In addition, it is impossible to judge the amount 
to be appropriated until the method in which it is to be spent 
has been determined. It is only by balancing the two fac- 
tors — the purpose to be accomplished by the advertising and 
the method of accomplishing this purpose — that it is possi- , 
ble to work out a well-balanced advertising program. i 

I 

Preparation of the Advertising Budget h 

The preliminary estimate of advertising expenses should 
be prepared by the advertising manager. He should have 
before him the contemplated sales plans of the business, and 
also be familiar with the general plans and policies of the 
business as a whole. If the advertising manager is sub- 
ordinate to the sales manager, he will submit his estimate 
to the latter for approval. In any case he must work in 
cooperation with the sales manager in formulating the ad- 
vertising program, as the advertising program is but one 
part of the sales program. The sales manager, or the adver- 
tising manager, depending on whether the latter is subordi- 
nate to the former, will transmit the advertising program 
to the executive in charge of the budgetary procedure, who 



THE ADVERTISING BUDGET 



117 



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Il8 BUDGETARY CONTROL 

will in turn submit it to the budget committee which will 
make such changes as it thinks necessary before approving 
it. As; will be shown in the manual on budgetary pro- 
cedure discussed in Chapter XXIII the budget committee 
will have before it all the proposed budgets at one time so 
that it [can consider them as a whole. If the committee 
thinks that important changes in the estimate are neces- 
sary, it will call the advertising manager before it and give 
him anj opportunity to defend his requests. 

After the estimate has been approved by the budget 
committee it may be submitted to the board of directors for 
consideration and approval. When it has been: finally 
approved, it then becomes the advertising budget for the 
current budget period. It will be transmitted by the execu- 
tive in charge of the budgetary procedure to the advertising 
manager and will constitute his working program for the 
period. 



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Form of the Advertising Budget 

The advertising estimate should be made in such form 
as to show: 

1. The lines of goods which are to be advertised and the amount to 

be spent on each of them. 

2. The methods by which the appropriation is to be spent and the 

amount to be spent by each method. 

The budget as approved will show the same information 
as the estimate and this makes possible the exercise of a 
proper control of advertising expenditures (i) by purposes 
and (2): by methods of expenditure. 

The executive in charge of the budgetary procedure is 
responsible for seeing that supplementary data are prepared 
and submitted to the budget committee with the advertising 
budget which will enable it to judge the possible results of 
the proposed advertising program. It is expected that a 



THE ADVERTISING BUDGET II9 

considerable portion of these data will be prepared by the 
advertising manager in support of his request. He should 
at least present data to show the anticipated effect of the 
proposed program on the volume of sales. The executive 
in charge of the budgetary procedure will usually have to 
supply the data showing the effect of the increased volume 
of sales on the manufacturing, selling, and administrative 
cost. In preparing this he may be assisted by the controller 
and his staff. 

Control of the Advertising Budget 

After the advertising budget is adopted it is necessary 
to take measures to secure its enforcement. The advertis- 
ing budget may be thought of as a fixed amount of money 
voted to the advertising manager by the budget committee 
or board of directors. So it is — the advertising budget is 
at once an estimate and a limitation of authority to spend. 
We have seen, however, that the sales program is based on 
trade conditions and must be currently modified and 
amended as trade conditions change. Similarly, the adver- 
tising budget is based on the sales program to a considerable 
degree and may need to be modified and amended when the 
sales program is changed. In order that the relation between 
the advertising program and the sales program may be 
clearly seen, it is desirable that there be prepared at the end 
of each month a report similar in form to Figure 5. 

Mr. W. A. McDermid, in Administration for July, 1921, 
suggests the following method of controlling the advertising 
appropriation : 

The physical control of the appropriations — the forms by means 
of which the advertising executive knows where he stands day 
by day — are relatively simple. They have been modified in 
many details for different concerns, but a majority are based on 
the following: 



120 BUDGETARY CONTROL 

1. The budget sheet: 

Regardless of the method by which the appropriation has 
been determined, there is laid out an estimate, roughly- 
distributed month by month, with subtotals at con- 
venient intervals. 

2. Detail sheet: 

(a) For space. These sheets show, with as miibh detail 

as may seem advisable, the publications, dates of 
insertion, size of space, and cost. The advertising 
agency usually works this out in compact form 
both for its guidance and approval. 

(b) For sundry costs. These sheets are usually more of a 

guess than the space sheets, but they cover esti- 
mates for literature, printing, engraving, and innu- 
merable incidental costs. They should be binding 
only as to outside limits. 

3. Budget control sheet (see Figure 6) : 

With this before him and his general budget approved, 
the manager knows where he stands all the time. If 
the appropriation or scale of expenditure warrants, this 
could be made weekly or even daily. 

The advertising budget presents a plan under which the 
advertising manager may engage expert labor, make news- 
paper contracts, etc. As such contracts are made and obli- 
gations incurred, the advertising budget comes by degrees 
to a stage where amendments are difhcult. For example, 
after a contract has been made for printing a shoe catalogue, 
it is of little use to decide that the money involved can be 
expended to better purpose in street-car advertising. A 
report is needed, therefore, which will show the amounts 
under each appropriation item still available for contract or 
for transfer to other purposes. Such a report may be made 
in the form of Figure 7. 

A little consideration of this report should make apparent 
the value and purpose of each of the columnar headings. 
Columns (i) to (4) inclusive show original plans and the 






1 



THE ADVERTISING BUDGET 



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THE ADVERTISING BUDGET 123 

changes made in these plans, with the present status of the 
appropriation as a result of these changes. Column (5) 
shows the cash disbursements which have been made. 
Columns (6) and (7) show the amounts which must yet be 
financed. Columns (8) to (10) inclusive show commitments 
which may or may not be subject to adjustment. Column 
(11) shows the amount available for new contracts or for 
transfer to other appropriations if this is found advisable. 

The reports used in exercising control of the advertising, 
like all reports used in budgetary control, must be made 
promptly and accurately if they are to be of service. This 
necessitates that the accounting department must render 
reports immediately after the end of the month or other 
period used as a basis for control, and it must maintain 
accounts which will provide a proper distribution of the 
expenditures incurred under the advertising budget. 



CHAPTER IX 
THE PRODUCTION BUDGET 

Relation of Production Budget to Sales Budget 

The sales program, as shown by the sales budget, con- 
templates the delivery of certain commodities or services to 
customers. To execute this program it is necessary that 
these commodities or services be produced by the firm which 
offers them for sale or that they be purchased from other 
firms. But these commodities or services must not be 
merely delivered ; they must be delivered at the time and in 
the quantity demanded by customers. This necessitates 
the making of plans which schedule deliveries from the 
factory or the vendors in such a manner that sales demands 
may be met. 

The execution of these plans requires the preparation of 
a production or purchasing budget, and the formulation of a 
production or purchasing program. The general principles 
involved in the control of the quantity of production and of 
purchases are very similar, but their application in the two 
cases are sufficiently different to make a separate treatment 
of the two problems desirable. It is the purpose of the 
present chapter to discuss the production budget. A later 
chapter will deal with the purchasing budget. 

Relation of Production Control to Production Policies 

From the viewpoint of budgetary control, manufactur- 
ing industries may be divided broadly into two general 
classes : 

I . Those which manufacture a standard commodity or commodities, 
and produce and place them in stock in anticipation of sales 
demands. 

124 



1 



THE PRODUCTION BUDGET 125 

2. Those which produce goods in accordance with the customers' 
specifications, and hence cannot manufacture for stock but 
only in response to orders. 

In the first case, it is necessary to plan production so as to 
have available the goods required when the sales order is 
received. In the second case, it is necessary to plan produc- 
tion so as to be able to produce the goods as quickly as 
possible after the order is secured. The preparation of a 
production budget for a manufacturing industry producing 
for stock, will be first explained. Such modifications as 
are necessary for a business producing on special order will 
then be stated. 

Adjusting Sales Plans with Production Capacity 

It has been explained in the discussion of the preparation 
of the sales budget that the sales estimate, as submitted by 
the sales units, should be revised by the production depart- 
ment with reference to production possibilities. In making 
these revisions the production department should not only 
consider the possibility of producing the volume called for 
by the sales estimate, but also the possibility of producing 
this volume at an economical cost. The sales estimate may 
call for the production of some items in such small quantities 
that they cannot be produced economically, or it may call 
for such a volume of production of some items that it would 
be necessary to incur so great an amount of extra expense to 
produce the amount required that it would be unprofitable 
to do so. 

It may also be that the sales estimate is such that it does 
not provide for a well-balanced production program. It 
may call for so many of some items and so few of others that 
the result would be the overloading of some departments or 
some machines, and a lack of work for other departments or 
other machines. The production department should have 



126 BUDGETARY CONTROL 

available data on production capacity which will indicate all 
this, so that it can suggest the necessary revisions in the 
sales estimate. 

To be able to make these revisions it is necessary for the 
production department to have data of two kinds : 

1. It must have an analysis of each of the products offered for sale 

which shows the manufacturing operations necessary in its 
production, 

2. It must have a record of each of the machines operated by the 

company, showing the operations the machine performs and 
the number of operations it can perform in a specified time. 

If these data are available it is possible to determine the 
volume of the operations required to produce the goods 
called for by the sales estimate and to balance this against 
the machine capacity of the plant. Three situations may 
arise : 

1. The sales budget may approximately equal the production 

capacity. This is the desirable result. 

2. The sales budget may exceed the production capacity, in which 

case one of three things must be done : 

(a) The sales budget may be reduced. 

(b) Additional equipment may be secured. 

(c) Some goods may be purchased from outside sources. 

3. The sales budget may be less than the production capacity, in 

which case it may be desirable to attempt to increase the sales 
program so as to provide for a more desirable production pro- 
gram. In some cases this may be impossible. Under these 
conditions some machinery may be left idle until an increase in 
sales can be secured. If it is evident that the decrease in sales 
is permanent, the production capacity may be reduced by the 
sale of the unnecessary equipment. 

It is not an easy matter to coordinate sales possibilities 
with production capacity. In fact it is one of the most 
difficult of administrative problems. The need for this 
coordination is so great, however, that it is worth while to 



THE PRODUCTION BUDGET 127 

Spend any amount of effort in order to secure it. The first 
step in the solution of the problem is the preparation of data 
to show what the possible sales are and what the available 
production capacity is. 

In so far as possible, a manufacturing business should 
select its machinery and equipment so that it will be well- 
balanced and flexible, as this makes it possible to adapt 
production to variations in sales demands. There is a 
limit, however, to the extent to which machinery can be 
adapted to different uses, and there should be an attempt to 
harmonize the sales program with the factory possibilities. 
Often it is possible to shift the emphasis of the sales program 
by means of extra efforts on the part of the salesmen and by 
the nature of the advertising, and to increase the sales of the 
items which the factory is best adapted to produce. 

Determination of Production Requirements 

If the production department makes a careful revision 
of the sales estimate, and if its recommendations are given 
proper consideration, the sales budget will represent factory 
requirements which are both possible and profitable. After 
the sales budget is adopted, the production department has 
an estimate of the requirements of the sales units during the 
next budget period. Presumably these requirements state 
the number of each item of goods manufactured by the 
company which must be provided to the selling units during 
the period. In order to translate these requirements of the 
sales units into an estimate of production for the period, it 
is necessary for the production department to take into 
consideration the inventory of finished goods at the begin- 
ning of the period and the estimated inventory of finished 
goods at the end of the period. 

To illustrate : The ten sales units of the X Manufactur- 
ing Company estimate their requirements from the factory 



128 BUDGETARY CONTROL 

for article Y for the next budget period to be 120. The ^( 
records of the factory show that the inventory of article Y 
at the beginning of the budget period is 30, and it is esti- 
mated that an inventory of 20 at the end of the period will 
be sufficient. The estimate of production on article Y for 
the period will be 120+20 — 30=110. Each item on the 
sales budget must be considered in the same manner in order 
to determine the estimate of production for the period. 

Relation of Inventory of Finished Goods to Estimate of Produc- 
tion 

But the problem of the production department is not 
merely to produce the quantity of goods that are to be sold 
during the budget period. It must do more than that; it 
must produce the goods in anticipation of sales orders and 
place them in the finished storeroom so that customers may 
be served promptly and according to the delivery dates 
given in the sales contracts. An easy solution of this prob- 
lem would be to manufacture before the beginning of the 
budget period, or shortly thereafter, all the goods that are 
to be sold during the period. For example, if the owners or 
officers of an automobile factory estimate that they will sell 
200 automobiles during the budget period, the production 
manager may manufacture and place in the storeroom these 
200 autoraobiles on or before the first day of the period. 
Such a procedure is clearly impracticable except in rare 
cases. 

In the first place, the production manager must distrib- 
ute his manufacturing processes throughout the year, so far 
as this is practicable, in order that he may make the fullest 
possible use of floor space in his factory and of machinery 
and equipment, and, more important still, in order that he 
may give employment continuously through the year to all 
of his skilled employees and to as many of his unskilled em- 



THE PRODUCTION BUDGET I29 

ployees as possible. From every standpoint it is clearly 
undesirable for the production manager to make up all the 
product in advance of the selling period and then shut down 
the factory for several weeks or months. To a less degree, 
it is undesirable for the production manager to operate his 
factory at 100 per cent capacity for eight months of the year 
and at 50 per cent capacity during the other four months. 
Under any system of finished stock control, there will be 
varying production requirements at different seasons of the 
year, but two very important considerations from the stand- 
point of the factory superintendent are : (a) that a sufficient 
amount of finished stock shall be on hand to meet sales 
orders, and (b) that this stock shall be constantly replen- 
ished from goods in process in the factory. 

In the second place, Kt is clearly undesirable to manu- 
facture goods in complete anticipation of the demands of 
the selling period, because of the large amount of capital 
required. If automobiles to the value of $500,000 are ex- 
pected to be sold during the year 1922, it is clearly undesir- 
able to have all these automobiles on the floor of the ware- 
room on December 31 , 192 1 . The $500,000 invested should 
be at productive use, and 'it is an economic loss to maintain 
stocks of finished goods on hand for any longer period than 
is absolutely necessary to make reasonably sure of prompt 
shipment to customers. \ 

'^From the foregoing discussion it can be seen that it is not 
enough to know the total amount to be produced during the 
budget period. It is necessary, in addition, to schedule 
production so that a sufficient amount of goods will be on 
hand at all times to meet sales demands and yet prevent an 
excess of inventory and the consequent loss on the capital 
invested. In order to accomplish this, it is necessary to set 
up a schedule for the inventory of finished goods and to set 
up a schedule of production which will maintain the in- 



130 BUDGETARY CONTROL 

ventory schedule. ' The ideal schedule woul,d be one which 
delivered to stock each day the exact amount of goods which 
would be solijd during the day. If such a schedule couM be 
maintained during 300 sales days of the year, the stock of 
goods in the finished goods storeroom would be turned over 
300 times. In such an ideal situation, $40,000 of stock 
might be delivered into the stockroom daily and be sold 
300 times. As will be seen readily, such a $40,000 stock so 
operated would satisfy the requirements of a sales volume 
of $12,000,000. 

Unfortunately the daily sales are not uniform in amount 
and production is not sufficiently standardized to insure 
a uniform daily /delivery to stock ; consequently, for both 
these reasons it is impossible to deliver into stock each day 
the same amount of goods that is to be shipped to customers 
on that day. / It is, therefore, necessary to carry an inven- 
tory to provide for the lack of coordination of sales arid pro- 
duction. A most important problem of production con- 
trol is to determine the desirable amount for this inventory 
and to plan production so as to maintain it at this amount. 

The inventory of finished goods is not a fixed or uniform 
amount. Since its purpose is to take up the slack between 
production and sales, this should -be evident. It is a con- 
stantly varying amount.^ Because of its constant flu^tua- — 
tions, it is necessary that an effective control be exercised 
over it. This control involves the following : 

1. The establishment of maximum and minimum limits, to serve as 

a check on its size. 

2. The establishment of adequate records and an adequate proce- 

dure to enforce these limits. 

"Maximum" and **Minimum" Limits as a Basis of Inventory 
Control 

"Maximum" and "minimum" limits should be estab- 
lished for each item of finished goods carried in stock. The 



THE PRODUCTION BUDGET 13I 

"maximum" states the amount above which the inventory 
should never be permitted to go except by special permission 
of the executive officers ; the "minimum " states the amount 
to which the stock of any item can be depleted before the 
placing of a production order to replenish it. When the 
sales orders reduce the stock to or below the minimum, a 
production order should be issued for the amount decided 
upon as the "quantity to order." 

The production department should establish minima, 
quantities to order, and maxima, in accordance with the 
following principles : 

1. There should be at all times sufficient stock on hand to satisfy 

customers' demands, if such demands are consistent with the 
capacity of the factory. 

2. There should not be larger stocks on hand than can be turned 

over in a period necessary for the production of a similar quan- 
tity, unless such quantities do not constitute an economical 
run. 

3. Goods should be produced in quantities large enough to insure 

economical production. 

The following factors should be considered in establish- 
ing minima, quantities to order, and maxima: 

1. Production period 

2. Probable sales 

3. Margin of safety 

4. Economical run 

Production Period 

The production period is the time required from the 
placing of an order until the finished goods are delivered to 
the storehouse. Obviously this period cannot be established 
exactly and will vary according to the quantity ordered, 
since it will take longer to produce 10,000 items than to 
produce 1,000 items. Sufficient data can be collected, 
however, to estimate the approximate length of this period 



132 BUDGETARY CONTROL 

for different quantities of production. In the absence of 
better statistics it may be necessary to use the average 
production period, as shown by the records of past produc- 
tion. Obviously investigation and study should be made 
to determine the desirability of this average period and 
changes made in the light of this investigation. 

Probable Sales 

The probable sales for the budget period are stated in 
the sales estimate. By using the ratio of the average pro- 
duction period to the budget period, the probable sales for 
the production period can be determined. To illustrate, 
if the production period is thirty days and the quarterly 
sales estimate is 600 units of item Y, the probable sales for 
the production period are 200. 

Margin of Safety 

Neither probable sales nor the length of the production 
period can be forecast with exactness. Consequently, if 
the minimum is established as the probable sales for the 
production period and a production order is issued when the 
minimum is reached, it will be only in rare cases that stocks 
on hand will be exactly depleted when the newly manu- 
factured product arrives at the storehouse. Probable sales 
may be oversold; strikes, breakdowns, and delays in de- 
liveries of raw material may interfere with the normal 
course of production. It becomes necessary, therefore, to 
have a quantity of finished goods on hand in excess of the 
probable sales for the production period at the time the pro- 
duction order is issued. This excess may be termed the 
"margin of safety." 

The margin of safety is usually estimated at from 10 to 
25 per cent of the probable sales for the production period. 
Its amount will vary in different businesses and may well 



THE PRODUCTION BUDGET 133 

vary with reference to different items in the same business. 
Whenever the inventory of any item falls below the margin 
of safety the production manager should be notified. He 
may find it necessary to resort to emergency measures to 
replenish the stock if there are indications that the margin 
of safety is not sufficient to supply the sales demand until 
additional stock is received from the factory. If a well- 
organized planning system is maintained, it will be possible 
to determine the length of time before additional goods will 
be received. It is, of course, not necessary to resort to 
emergency production or purchasing each time the inven- 
tory falls below the margin of safety. In fact, its purpose is 
to provide for just such cases. It is desirable, however, to 
call the attention of the production executive to the fact 
that the margin of safety is reached so that he may take ac- 
tion if he deems it necessary. Used in this manner, the 
limit set by the margin of safety serves as a danger signal. 

Economical Run 

In determining the "economical run" it is necessary to 
determine the time necessary for "tearing down" and 
"setting up " the machines used in making each item. This 
involves the collection of data showing machine operations, 
so that the machines required in the production of each item 
can be determined and the cost involved in "setting up" 
these machines for the production of each item estimated. 
It is impossible to set an arbitrary standard for, or to de- 
termine with exactness just what constitutes, an economical 
run, but certain limits can be set up. The problem of 
determining what constitutes an economical run usually 
arises only in connection with slow-moving items, of which 
only a limited amount is sold during the production period. 
In the consideration of such items, it is necessary to offset 
the high unit cost of producing them in small quantities 



134 BUDGETARY CONTROL 

against the capital cost of carrying a large inventory. Con- 
siderable judgment must be used and considerable research 
should be carried on in determining the most profitable pro- 
cedure. Such a study may often result in the elimination of 
some items from the manufacturing program. It may be 
determined that it is cheaper to purchase the small amount 
needed from other manufacturers, or it may be decided to 
eliminate them from the sales program. Whether they can 
be eliminated from the sales program will depend, of course, 
upon the effect of this elimination on the sale of other items. 

Method of Calculating "Maximum" and "Minimum" 

As previously explained, the probable sales for the pro- 
duction period are the quantity expected to be turned over 
during that period. The margin of safety is the amount 
which it is thought necessary to carry in addition to insure 
against contingencies. Therefore, the quantity to which 
stocks can be depleted before a production order is started 
is the sum of the probable sales for the production period 
and the margin of safety. This is the minimum. When- 
ever stocks are depleted to this quantity, a production order 
is started. The product specified on the order goes through 
the production process and arrives at the storeroom, ideally, 
when stocks have been reduced to the margin of safety. 

Quantities to order must be established under two sets 
of conditions. Each condition of facts will influence the 
quantity which is to be ordered. These conditions and the 
procedure in each case are as follows : 

1. Where the probable sales for the production period is less than 

the amount of the economical run, the latter amount becomes 
the quantity to order. 

2. Where the amount of probable sales for the production period is 

equal to or greater than the amount of the economical run, the 
former amount becomes the quantity to order. 



THE PROI>UCTION BUDGET 135 

The maximum is the sum of the minimum and the 
quantity to order. It is the danger mark which must not be 
exceeded. In the case of many products the maxima will 
never be reached, since, during the time that goods are being 
produced, stocks on hand are being depleted by shipments 
on orders. From the foregoing it can be seen that the 
maximum is established by adding to the minimum the 
*' normal" quantity to order, that is, the quantity to order 
in case the production order is issued when the stock on 
hand exactly equals the minimum. As a matter of practice, 
the production order is usually issued when the inventory is 
slightly below the minimum, since the sales order which re- 
duces the inventory to the minimum will probably reduce it 
somewhat below. In some cases it is better for the produc- 
tion order to be made out for the difference between the 
actual inventory and the maximum, than to be made out 
for the difference between the minimum and the maximum. 
The reasons for this are apparent. 

Finished Goods Records 

To enforce the requirements with reference to maxima, 
quantity to order, and minima, as outlined in the preceding 
paragraphs, it is necessary to maintain a finished goods 
record which provides a perpetual inventory of finished 
goods. The maximum, quantity to order, and minimum, 
as established for each item of finished stock, will be shown 
on the finished goods record. Usually this record is kept 
in what is termed a "balance of stores" form which is espe- 
cially adapted for exercising effective inventory control. 
The form of a balance of stores record is illustrated in 
Chapter X. 

It should be understood that it is not intended to lay 
down an arbitrary procedure in the foregoing discussion. 
The method of establishing maxima, minima, and quanti- 



1 



136 BUDGETARY CONTROL 

ties to order has been discussed somewhat in detail, and a 
definite procedure has been explained in order to indicate 
the problem involved in enforcing a production budget 
based on a sales budget. Although the procedure outlined 
is typical of that which must be employed by any factory 
which produces for stock and which attempts to execute a 
production program in a systematic manner, variations of 
considerable consequence will of necessity be made in 
adapting this procedure to particular cases. 

Relation of Production Planning to the Production Budget 

A balance of stores record properly operated results in 
the issuance of production orders with sufficient frequency to 
provide for the replenishment of stock in accordance with 
the finished goods schedule prepared under the production 
program. But in order that these production orders may 
result in deliveries according to schedule, it is' necessary that 
there exist an effective production control. Such control 
usually necessitates the establishment of a systematic 
organization to carry on production planning. This 
organization is usually called the planning department. It 
is not possible or desirable to discuss here the organization 
and operation of a planning department. This is a matter 
of production management. It is important to keep in 
mind, however, that the planning function must be per- 
formed either by a separate organized department or by 
different individuals in different departments, if the produc- 
tion budget is to be translated into an effective production 
program. 

Relation of Production Costs to the Production Budget 

The preceding discussion has treated primarily of the 
problem of producing the volume of finished goods called J 
for by the production budget. What constitutes finished ! 

t 



I 



THE PRODUCTION BUDGET 137 

stock in a particular business depends upon the character 
of the product offered for sale to customers of the business. 
The finished stock of the X Foundry Company becomes the 
raw material of the Modern School Desk Manufacturing 
Company. The lumber, as it comes from the mill of a 
lumber company, may be finished stock if the lumber com- 
pany offers the green lumber for sale to its customers. Or 
sawed lumber may be seasoned and planed, and so made 
into finished lumber of the higher grades. Materials are 
either (a) raw materials ; (b) goods in process ; or (c) finished 
stock, depending upon the stage of their utility to the 
customers of the selling company. 

For census purposes we may classify certain materials 
as "raw materials," or basic materials, but that classification 
does not hold in the reports of any particular company 
where the only test must be that finished stock is stock in 
the form demanded by customers. 

The finished stock of a company may be produced in the 
factory of the company from raw materials ; or it may be as- 
sembled and altered from parts in the alteration room of the 
company; or it may be purchased as finished stock. The 
present discussion is confined to a consideration of the 
finished stock of a manufacturing company which is 
produced in its factory. All such stock is produced by the 
employment of labor and equipment in the performance of 
certain operations upon raw materials by which they are 
transformed into the finished product. 

Although it is not the function of the budgetary pro- 
gram to prescribe the method by which production is 
carried on, since this is the province of the planning 
department, it is necessary for effective production con- 
trol that a budget be prepared for each of the elements 
of production cost — materials, labor, and overhead — to 
the end: 



138 BUDGETARY CONTROL 

1. That the necessary amount of materials and labor will be avail- 

able and excess amounts will be prevented. 

2. That the cost of materials, labor, and overhead shall be under 

effective control. 

3. That the cost of financing the production program may be 

determined for the purpose of the financial budget. 

The preparation of the materials, labor, and manufactur- 
ing expense budgets will be discussed in the chapters im- 
mediately following the present one. 

Control of Production on Special Orders 

Many manufacturing businesses receive some special 
orders for goods which they do not carry in stock but which 
they produce in response to the requests of customers. 
There are a few businesses which produce all their goods in 
accordance with the customers' specifications, and therefore 
produce only on special orders. A foundry is a good illus- 
tration of the latter class. In either case, the problem of 
production control is not greatly different from that of the 
business which manufactures for stock on standard orders. 

In the case of a business which manufactures on both 
standard and special orders, it is necessary to determine 
what proportion of the orders received will be special orders. 
In making the sales estimate the special orders should be 
estimated separately, so that the production department 
can estimate the goods to be produced for stock and those 
to be produced to order. To make an accurate estimate of 
the probable special orders to be received, it is necessary to 
make a careful analysis of past sales to learn the trend of 
special orders by years and by territories. The effect of 
market conditions on the number of special orders received 
may also be useful. The policy to be followed in handling 
special orders — whether they are to be given the right of 
way or are only to take up unused time — will have a con- 
siderable bearing on the planning for their control. 



THE PRODUCTION BUDGET 139 

Whether a business manufactures on standard or special 
orders, the first step in the planning of production control is 
the preparation of the estimate of production. The next 
step is to provide for the performance of this estimate. 
This involves the preparation of three supplementary es- 
timates : the estimate of labor, the estimate of manufactur- 
ing expense, and the estimate of materials. When goods 
are produced for stock it is necessary to take into considera- 
tion the finished goods inventory requirement in determin- 
ing the production requirements, while in the case of special 
orders the question of finished goods does not enter. It is 
necessary, however, to estimate carefully the quantity of 
production, so that the necessary labor and materials may 
be secured. It is usually urgent to produce the goods called 
for by special orders as quickly as possible, which makes it 
the more imperative that plans be made carefully, so that 
delays will not result from a lack of materials or labor. 

It can be seen, therefore, that the preceding discussion, 
with the exception of that dealing with the control of finished 
stock, applies equally well to a manufacturing business 
producing for stock and to one producing on special orders. 

Preparation of Production Budget 

As shown by the foregoing discussion, the production 
budget is the result of a coordination of the sales possibili- 
ties and the production capacity. Its preparation involves 
a procedure similar to the following : 

I. Preparation of Sales Budget: 

1. Sales estimates are prepared by sales units. 

2. These are revised by the general sales office. 

3. They are then forwarded to the production department 

where a comparison is made between the requirements of 
sales estimates and the production capacity. If the 
production department thinks revisions are necessary 
these are shown on the sales estimates. 



HO BUDGETARY CONTROL 

4. Estimates as approved by the production department are 
forwarded to the budget committee for final revision and 
approval. This committee will decide any differences 
which may exist between the programs of the sales and 
the production department. 

II. Preparation of Finished Goods Budget: 

1 . Estimate of finished goods requirements prepared from the 

sales budget by the production department. 

2. This estimate is forwarded to the budget committee for its 

consideration and approval. 

3. After the estimate of finished goods is approved by the 

budget committee, it is enforced by the production de- 
partment by means of the balance of stores records 
operated under maximum and minimum standards. 

It will be noticed that the "production budget" really 
resolves itself into a "finished goods" budget. In order to 
carry out this budget it is necessary to prepare supplemen- 
tary budgets for materials, labor, and manufacturing 
expense. 

It is usually necessary to have the production budget 
prepared in the office of the production manager. It is 
desirable to have the records of machine capacity centralized 
and these are often kept in the central office. In some cases 
these records are kept by the planning department, which 
may then perform the detail work involved in the prepara- 
tion of the production budget, whereupon the budget will 
be carefully revised by the production manager before it is 
submitted to the budget committee. 

Control over Production Budget 

To exercise control over the production budget and to I 
make revisions when necessary, monthly reports are re- I 
quired which show a comparison between the estimated and f 
the actual performance. These reports will vary some- 
what, depending on the one for whose use the report is ^ 



THE PRODUCTION BUDGET 



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142 BUDGETARY CONTROL 

intended. The balance of stores records are intended to 
enforce automatically the production budget; but no 
matter how carefully these records are operated, errors will 
occur which will make them fail to accomplish this purpose 
perfectly. When these errors occur, they ought to be 
detected as quickly as possible and measures taken to 
remedy them. 

For the use of the general officers a finished stock 
budget report made in the form shown in Figure 8 is very 
serviceable. 

This report serves to show to what extent coordination 
between sales and production is being achieved. If the 
commodities sold by the company are not too numerous, 
each commodity should be shown on this report. Where 
the commodities are very numerous, it will be necessary to 
show them on this report by groups or classes. In this case 
judgment must be used in interpreting the report, for it is * 
obvious that there might be very close coordination be- i 
tween the sales and production of a group and yet there j 
might be items in the group on which large inventories j 
existed and other items for which unfilled orders were on i 
hand. I 

The amount shown in column (2) in Figure 8 is taken 1 
from the last revision of the sales estimate. Column (3) | 
shows the estimated quota for finished goods based on the | 
estimated sales shown in column (2). Column (4) shows \ 
the actual sales for the month, and column (5) shows the } 
revised finished goods quota, the revision being based on the ^ 
actual sales as shown in column (4). Column (6) shows 
the actual deliveries to stock of finished goods. Columns 
(2) and (4) provide a comparison of estimated and actual 
production for the month. Columns (5) and (6) provide a 
comparison between the actual production and the revised 
production quota. A comparison of columns (3), (5), and 



THE PRODUCTION BUDGET , 143 

(6) will show two things: (a) by how much the original 
estimate of production was incorrect ; and (b) how much the 
actual production varied from the estimated. The informa- 
tion shown in column (4) is taken from the sales records for 
the month, and the information shown in column (6) is 
taken from the balance of stores records. Column (7) 
shows the difference between columns (5) and (6). Column 
(8) shows the manufacturing orders outstanding in the 
factory at the end of the month. These orders should be 
shown by the records of the planning department and also 
on the balance of stores records. Column (9) shows the 
amount to which the production budget for the next month 
should be revised. 

If a monthly quota system is maintained on stock 
deliveries, the unfilled orders at the end of the month as 
shown by this report furnish valuable data for use in pro- 
duction control. It is possible that a large amount of un- 
filled orders represents poor production management. In 
some cases these unfilled orders may be due to traffic mis- 
management, to poor warehouse control and operation, to 
general trade depression, or to strikes and similar causes. 
In each case the data given in the report as to outstanding 
unfilled orders presents material for executive judgment, 
executive orders, and executive discipline and control. 
Such a budget and reporting system makes use of sales, 
inventory, and production accounts as a basis for future 
plans. The reports under such a system offer comparisons 
between estimated sales and estimated production, and 
actual sales and actual production. Such reporting makes 
constant use of accounts, and the requirements of the re- 
ports to be made determine what grouping of sales ac- 
counts should be followed. Similarly, reporting require- 
ments indicate the analysis to be followed in classifying 
inventory accounts and cost sheets. 



144 BUDGETARY CONTROL 

Significance of Finished Stock Budget Report 

Every functional officer of a factory has his own partic- 
ular interest in the showing made in the monthly report of 
delivered and undelivered orders under the monthly quota. 
The officer in charge of the employment of labor studies the 
outstanding orders and quota balances with reference to 
labor that may be needed in meeting rush deliveries into 
stock. The traffic manager is vitally interested in out- 
standing orders, since the amount for a given item may or 
may not indicate the necessity for action as to terminal 
facilities, warehousing, reloading, and the like. The ad- 
vertising manager notes with concern the balances in quotas 
for which orders have not been placed, since such balances 
may indicate a departure from advertised promises of serv- 
ice. Or the monthly report may show production in 
excess of quotas and may indicate to the sales manager 
the necessity for extra efforts to move the surplus inven- 
tory. Of course, the treasurer is interested in the amount 
of outstanding orders and the problem of financing their 
production. 

The monthly report discussed in the foregoing paragraphs 
furnishes the basis for immediate raanagement decisions. 
It also provides a progressive month-by-month commentary 
on the accuracy of the estimating and planning in the busi- 
ness. Such monthly reports reveal errors in business judg- 
ment and make for better estimating for the next budget 
period. 



CHAPTER X 
THE MATERIALS BUDGET 

Need for Estimate of Materials 

After the finished goods which are to be produced during 
the budget period are determined by means of the produc- 
tion budget, it is necessary to estimate the materials which 
are necessary to produce these goods. This estimate is 
necessary : 

1. That the purchasing department may make plans by which ^ 

to secure the necessary materials by the time they are 
needed in production. 

2. That the treasurer may know the probable disbursements re- 

quired by the purchasing program and can plan to obtain the 
funds necessary to meet these disbursements. 

3. That the budget committee may be able to see the financial re- 

quirements of the proposed sales and production programs at 
the time they are submitted to it for consideration. It will 
be shown in a later chapter that all the departmental budgets 
are used as a basis for the preparation of a financial 
budget, which the budget committee uses as a means of judg- 
ing the desirability of the proposed budgets. The materials 
budget usually gives rise to one of the largest of the disburse- 
ment items on the financial budget. Its use is therefore essen- 
tial to the preparation of the financial budget. 

4. The materials budget is also necessary for the preparation of the 

estimated balance sheet and estimated statement of profit and 
loss, which are discussed in Chapters XXI and XXII. 

Determination of Material Requirements — By Commodities ^^ 

In the same manner in which the production department 

maintains an analysis of each of its products to show the 

manufacturing operations required in its production, it 

should maintain an analysis which will show the materials 

10 145 



146 BUDGETARY CONTROL 

required in the production of each commodity. By the use 
of this analysis it is possible to estimate, on the basis of the 
production budget, the materials which will be required to 
produce the goods called for by the production program. 
The preferable way of making this estimate is to take each 
item on the finished goods or production budget, and to 
determine the amount of each kind of material which will be 
required to produce it. To illustrate, the production budget 
calls for the manufacture of 1,000 cast iron valves of X size. 
The product analysis shows that it takes 4 pounds of pig 
iron to produce this valve. Consequently it will be neces- 
sary to purchase 4,000 pounds of pig iron to make possible 
the production of the 1,000 valves. If each item on the 
production budget which requires the use of pig iron is con- 
sidered in this manner, the total purchases of pig iron can 
be determined. In the same manner each item on the 
production budget will be considered to determine the 
amount of materials of each kind that is necessary for 
its production. 

It is easy to see that this method of determining the 
material requirements may in some circumstances be quite 
difiicult. In the first place, there may be so many commodi- 
ties produced and so many different kinds of materials may 
enter into each that it may require an immense amount of 
clerical work to determine the material requirements for 
each commodity. Again, there may be a considerable varia- 
tion between the quantity of raw material required in the 
production of a commodity and the quantity of material 
which is in the finished product. This is due to shrinkage 
and waste, which are usually unavoidable. If this shrink- 
age and waste are fairly uniform, as they should be under J^ 
normal conditions, it is possible to estimate them fairly I 
accurately, but in some cases it is difficult to estimate their J 
amount with any accuracy. * 

1 



THE MATERIALS BUDGET I47 

By Ratios of Former Periods 

In some cases, instead of estimating the material require- 
ments for each commodity produced, it is expedient, in order 
to obtain the probable material requirements for the period, 
to find the ratio between the production volume for several 
periods and the volume of materials of each kind required 
for this production, and apply these ratios to the production 
budget of the current period. These estimates will be more 
accurate if separate ratios are determined for different classes 
of product manufactured. The reason for this is apparent, 
for different quantities of raw material will be required for 
different classes of finished product and the ratio between the 
different classes is apt not to remain the same during dif- 
ferent periods. 

To take a simple illustration, the M Manufacturing 
Company produces 10,000 different articles which can be 
grouped into three principal classes, known as Class A, 
Class B, and Class C. The articles in each class are com- 
posed of the same materials but vary as to size and design. 
The three principal raw materials used in the manufacture 
of the three classes are the commodities X, Y, and Z. Each 
of these commodities is used in the manufacture of each 
class, but in varying degrees. Commodity X is used prin- 
cipally in the production of Class A, commodity Y princi- 
pally in the production of Class B, and commodity Z prin- 
cipally in the production of Class C. It may be assumed 
that in terms of pounds the ratios are as follows : 

Class A — Commodity X 60%, Y 20%, Z 10% 
Class B — Commodity X 10%, Y 60%, Z 20% 
Class C — Commodity X 20%, Y 10%, Z 60% 

The remaining 10 per cent in each case is composed of mis- 
cellaneous materials. 

If the ratio between the tonnage of the three classes 



/ 



148 BUDGETARY CONTROL 

fluctuates from period to period, it can be readily seen that 
the quantity of X, Y, and Z required in production would 
fluctuate accordingly. For instance, if it is determined that 
it is desirable to increase the production of A 20 per cent and 
to decrease the production of C a like amount, the effect on 
the requirements for each of the commodities X, Y, and Z 
is apparent. There are few businesses producing several 
different articles in which the ratio between the volume of 
these articles produced each year does not vary raaterially. 
The foregoing illustration serves to show that if such varia- 
tions exist, inaccuracies will result from estimating the 
material requirements by the use of the ratio of materials 
to total production. 

Standard Material Rates as an Aid 

During recent years accountants and industrial engineers 
have given much attention to the development of standards 
by which to judge production. The principal emphasis has 
been placed on standard rates for manufacturing expenses, 
but there has been some consideration given to the develop- 
ment of standard rates of material and labor. There seems 
to be no good reason why standard material rates should 
not be developed. If these are set up they will serve at least 
three useful purposes: 

1 . They can be used in the estimating of costs and the establishment 

of prices on contracts. 

2. They will serve as a means of judging the efficiency of the manu- 

facturing operations and will assist in the elimination of waste 
due to errors or improper use of material. By comparing the 
material used with the standard, it will be possible to locate the 
excessive use of material. 

3. They will be of important service in estimating material require- 

ments and in preparing a purchasing program. 

Where standard rates of material to be used in the man- 
ufacture of each product are established, the task of pre- 



THE MATERIALS BUDGET 149 

paring the materials budget is greatly lessened. It is only- 
necessary to multiply the standard rate of material set on 
each commodity by the number of units of that commodity 
which is to be produced, to determine the material require- 
ments. 

Relation of Materials Requirements to Materials Inventory 

By means of one of the methods explained in the fore- 
going discussion it is possible to estimate the materials re- 
quired to satisfy the production program. To translate 
the requirements of the production program into an estimate 
of materials which will serve as a basis for the materials 
budget, it is necessary to take into consideration the inven- 
tory of materials at the beginning of the period and the 
estimated inventory of materials at the end of the period. 
To illustrate : The production budget calls for the manu- 
facture of 1,000 articles X, and it is estimated that it will 
take 4,000 pounds of commodity Y to produce these. The 
records of the factory show that the inventory of com- 
modity Y at the beginning of the budget period is 1,300 
pounds, and it is estimated that an inventory of 1,200 
pounds at the end of the period will be sufficient. The esti- 
mate of materials on commodity Y for the period will be 
4,000 lbs. + 1,200 lbs. — 1,300 lbs. = 3,900 lbs. Each com- 
modity which is to appear on the materials budget must 
be treated in this manner if an accurate estimate is to be 
prepared. 

But the problem of the purchasing department is not 
merely to purchase the quantity of materials that are to be 
used in production during the budget period. It must do 
more than that ; it must purchase the materials in anticipa- 
tion of factory requisitions and place them in the storeroom 
so that the needs of the factory may be served promptly. 
An easy solution of this problem would be to purchase before 



I50 BUDGETARY CONTROL 

the beginning of the budget period, or shortly thereafter, all 
the materials required during the period. For example, if 
the officers of a foundry estimate that lOO tons of pig iron 
will be required during the budget period, the purchasing 
agent may purchase and have on hand the lOO tons on or 
before the first day of the period. Such a procedure is 
clearly impracticable except in rare cases. 

In the first place, it is clearly undesirable to purchase 
materials in complete anticipation of production require- 
ments because of the large amount of capital required. If 
this procedure is followed, a large part of the capital invested 
in the materials is tied up for a considerable period of time 
before the materials are needed. It usually is desirable not 
to maintain stocks of materials on hand for any longer period 
of tirae than is necessary to make reasonably sure of the 
prompt satisfaction of factory requisitions. There are of 
course circumstances which make another procedure de- 
sirable, and these are discussed later in this chapter. 

In the second place, it is usually not profitable to main- 
tain storehouses of sufficient capacity to provide space for 
an inventory of raw materials in excess of that needed to 
meet the current demands of the production program. The 
space required for such storerooms is usually costly and the 
labor required to care for them is an additional expense. 
Again, if the material is subject to deterioration or obso- 
lescence, it may decrease in value during the time it is left 
in the storeroom. Insurance and taxes may also be in- 
creased because of its possession. 

From the foregoing it can be seen that it is the problem 
of the purchasing department to schedule deliveries of ma- 
terials so that a sufficient amount of materials will be on 
hand at all times to meet the production needs and yet not 
be excessive with the consequent loss arising from such 
excess. To accomplish this it is necessary to set up a 



THE MATERIALS BUDGET 151 

schedule for the inventory of materials to be maintained and 
one for deliveries which will maintain the inventory schedule. 
The ideal schedule would be one which delivered to stock 
each day the exact amount of goods which would be sold 
during the day. If such a schedule could be maintained 
during 300 production days of a year, the materials stock 
would be turned over 300 times. 

Unfortunately the daily factory requisitions are not 
uniform in amount, and purchase deliveries cannot be en- 
forced with sufficient exactness to insure a uniform daily 
delivery to stock; consequently it is impossible to deliver 
into stock each day the amount of materials that is to be 
requisitioned by the factory on that day. It is necessary, 
therefore, to carry an inventory to provide for the lack of 
coordination of purchase deliveries and production require- 
ments. It is the problem of the purchasing department, 
acting in cooperation with the production department, to de- 
termine the desirable amount for this inventory and to plan 
a purchasing program that will maintain it at this amount. 

The inventory of materials is not a fixed or uniform 
amount. Since its purpose is to take up the slack between 
purchase deliveries and production requirements, it should 
be evident that it is a constantly varying amount. Because 
of its constant fluctuations, it is necessary that an effective 
control be exercised over it. This control involves the 
following : 

1. The establishment of maximum and minimum limits, to serve as 

a check on its size. 

2. The establishment of adequate records and an adequate proce- 

dure to enforce these Umits. 

Maximum and Minimum Limits as a Basis of Inventory Control 

Maximum, minimum, and quantities to order are used in 

the same manner in the control of raw materials as they are 



152 BUDGETARY CONTROL 

used in the control of finished goods. The factors which 
must be considered in the establishment of these quantities 
for materials are somewhat different in terminology from 
those which determine the same quantities for finished 
goods, but they are very similar in nature. Instead of 
considering the production period, it is necessary to consider 
the purchasing period, or the length of time between the 
sending of the purchase order and the receipt of the goods. 
Instead of considering probable sales, it is necessary to con- 
sider the probable factory requisitions for materials. Instead 
of considering the economical run, it is necessary to con- 
sider the economical quantity to purchase with reference to 
terms, price, and deliveries. 

The method by which these facts must be considered in 
establishing control of raw materials should be apparent 
after the rather extensive explanation of the control of fin- 
ished goods which has been given in the preceding chapter. 

Record of Materials 

To enforce the requirements with reference to maximum, 
quantity to order, and minimum, it is necessary to maintain 
a materials record which provides a perpetual inventory of 
raw materials. The maximum, quantity to order, and 
minimum, as established for each item of materials, will be 
shown on the materials record. Usually this record is kept 
on what is termed a ''balance of stores form," which is 
especially adapted for exercising effective inventory control. 

There are many variations in the form of the balance of 
stores record. A typical form is shown in Figure 9. 

To illustrate the use of this type of balance of stores, the 
entries appearing thereon will be explained. Suppose that 
on the day the balance of stores record is opened, April i, a 
physical inventory shows that there are 12,500 pieces in the 
stockhouse bin. This quantity is entered in the balance 



THE MATERIALS BUDGET 



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154 BUDGETARY CONTROL 

column. This column shows at all times the amount on 
hand. After looking through the files of factory requisitions 
it is found that all requisitions for this particular commodity 
have been filled so that the quantity of 12,500 is available 
for use. This quantity would be entered, therefore, in the 
Available or Shortage column. An examination of the pur- 
chase order files shows that there is outstanding a purchase 
order for 10,000 pieces of this commodity, this amount being 
the Quantity to Order. The 10,000 on order is entered in 
the ordered column. The record is now ready for the receipt 
of the current entries. 

On April 5 a factory requisition. No. E 6784, is received 
for 4,000 pieces. The number 4,000 is entered in the Applied 
column and substracted from the amount in the Available 
or Shortage column, thereby reducing the balance in this 
column to 8,500. On April 10 the quantity specified on 
requisition E 6784 is delivered to the factory and an entry 
is made in the Issued column, reducing the Balance column 
to 8,500. The other entries for requisitions received, bal- 
ance on hand, and quantities delivered to factory, are simi- 
lar to the ones described above. On May i, 10,000 pieces 
of stock are received from the vendors to whom purchase 
orders have previously been issued. This quantity is en- 
tered in the Received column and added to the quantity in 
the Balance column and the Available or Shortage column. 

The value of the Applied column lies in the fact that it 
makes possible the reserving of materials for use on an order 
though it may not be desirable to requisition them from 
stock at once. In a factory operated under a proper plan- 
ning system, a "bill of materials" showing the materials 
required for the entire order is prepared for each production 
order issued. On the basis of this bill of materials entries 
are made on the materials balance of stores reserving the 
materials needed for the order. Some of these materials 



THE MATERIALS BUDGET 1 55 

may not be taken out of stock for several days, but it is de- 
sirable that they be reserved so that there will be no danger 
that the order may be delayed because of the lack of ma- 
terials. If this method is not followed, materials may be 
on hand when th^ order is issued but before the materials 
are requisitioned from stock they may have been used on 
another order. 

Relation of Purchasing Policies to Materials Budget 

In the preceding discussion it has been assumed that the 
materials budget is based on the production requirements 
and that the purchases will be scheduled to correspond with 
the production schedule. The only deviation from this 
assumption which has been recognized in the foregoing dis- 
cussion, is that in establishing quantities to order care must 
be taken to see that the quantities stated are sufficient to 
constitute economical purchases. In determining what con- 
stitutes an economical purchase it is necessary to consider 
(i) the possibility of getting lower prices or better terms 
by making larger purchases, and (2) the possibility of 
saving in freight costs by purchasing in large lots instead 
of small ones. In each case it is necessary to balance the 
savings which may be made by purchasing in large quanti- 
ties against (i) the loss incurred by tying up capital in excess 
inventories, (2) the possible loss due to deterioration or de- 
crease in price of the inventory, and (3) the possible financial 
embarrassment which may result from having capital in- 
vested in inventory which cannot be quickly realized. 

There are many factors which may affect the purchasing 
policy of a firm, and there are some of these which are op- 
posed to the control of purchases by budget. For instance, 
some firms think it is a function of the purchasing depart- 
ment to speculate on market changes and tendencies. In 
these firms, during periods of rising prices, large quantities 



156 BUDGETARY CONTROL 

of materials will be purchased and deliveries scheduled far 
in excess of production demands. It is undoubtedly true 
that under these circumstances a firm may make large sav- 
ings by placing large orders while the prices are increasing. 
It obtains materials for future use at a lower price than it 
could obtain them if it waited to purchase them when 
needed. It is also more assured of their delivery than if it 
waited until their purchase is indicated by the materials 
budget. 

This policy is apt to prove a dangerous one if careful 
control is not exercised. If the purchasing department is 
once given the opportunity to purchase in large quantities, 
unrestrained by the limitations of present requirements as 
shown by the materials budget, it is apt to make the most 
of its opportunity and continue the policy of quantity buy- 
ing as long as prices continue to rise. When the turn in 
prices comes, the firm is apt to find itself burdened with an 
inventory far beyond its needs, with large deliveries sched- 
uled to be made for several months, all of which has been 
purchased at the peak of prices. In many cases, even if the 
firm escapes serious financial embarrassment it loses more 
on its high-priced inventories than it gained from the quan- 
tity buying during the period of rising prices. 

A falling price level often has the opposite effect on the 
purchasing policy of many firms. The possibility of buying 
materials in the near future at reduced prices and the ease 
with which goods can be procured tend toward ''hand-to- 
mouth" buying. It is very desirable to exercise caution 
during a period of declining prices, but the purchasing policy 
may be so conservative that it will result in a decided loss. 
Parsimonious buying may result in unbalanced inventories 
and make it impossible to give proper service to customers, 
with the consequent loss of trade. Small purchases may 
also result in higher prices and freight rates. 



THE MATERIALS BUDGET 1 57 

It is the author's opinion that the purchasing depart- 
ment is not equipped to speculate and that it is not its 
function to attempt to do so. We have not yet developed 
methods of forecasting with sufficient accuracy to make it 
possible to speculate on market trends without the incurring 
of great risk. As Mr. Arthur E. Swanson very well says in 
the November, 1921 Administration: ''The difficulty which 
even very experienced and well-trained business men en- 
counter in predicting even approximately the trend of price 
levels and business activity, has caused many to follow a 
sort of straddling policy in reference to economic trends. 
They do not buy very far in advance when the level ap- 
pears to be on a long upward swing, or very close when 
the level appears to be on a downward swing. They are 
satisfied with an average buy." 

Whatever may be the purchasing policy of a firm, it is 
the function of the materials budget to show the materials 
required by the production program, and to show a schedule 
of deliveries which will meet the needs of this program. If 
the management desires to disregard the purchasing pro- 
gram shown by the budget in order to carry into effect pur- 
chasing policies which it has adopted, that is its privilege. 
It is the opinion of the author that it is only in exceptional 
cases that it is wise for it to do so. 

The **Stores" Budget 

The purchasing department purchases not only the ma- 
terials which become a part of the manufactured product, 
but also numerous "supplies" which are used in carrying on 
the manufacturing operations. It also purchases the sup- 
plies used by all the operating departments. Under a well- 
developed system of inventory control it is customary to 
term as " stores " all the materials purchased for all purposes 
and to place them in a storeroom from whence they are 



1 58 BUDGETARY CONTROL 

requisitioned for use. When the requisitions are issued it 
is indicated whether the stores for which they call are to be 
charged as "materials" or as "supplies." 

Because of this method of handling materials and sup- 
plies, it is the practice of some firms to prepare a stores 
budget which takes the place of the materials budget. The 
stores budget includes the estimated purchases for both 
materials and supplies. It is claimed that it is easier for 
the purchasing agent to make a stores budget than it is to 
estimate separately the materials and supplies. It is also 
claimed that it is easier to compare the estimated with the 
actual performance if the materials and supplies are shown 
in one budget. This contention is based on the fact that 
both the materials and supplies are charged to a Stores 
account when purchased and are not distributed as between 
materials, manufacturing expense (manufacturing supplies 
are charged to manufacturing expense when consumed) and 
departmental expenses, until they are requisitioned from the 
storeroom for use. Consequently the stores accounts give 
a ready means of checking the estimate of purchases, while 
the materials and manufacturing expense accounts do not, 
since purchases do not correspond with consumption during 
any specific period. 

There is considerable merit in these contentions, and the 
author has found it advisable in some cases to prepare two 
budgets, the first based on purchases and the second on con- 
sumption. The consumption budget is essential if standard 
costs are to be established for material, labor, and manufac- 
turing expense, and it is the belief of the author that such 
standards are essential for effective production control. 

Preparation of Materials Budget 

After the production budget is prepared, the production 
department can prepare an estimate of the materials re- 



THE MATERIALS BUDGET 1 59 

quired to produce the goods called for by this budget. If a 
well-developed planning department is in operation, it will 
have available data which will make it possible to prepare 
this estimate without difficulty. In such cases it is custo- 
mary to delegate the preparation of the materials estimate 
to the planning department. After its preparation, the 
materials estimate is carefully examined by the production 
manager and his staff. If there is not a planning depart- 
ment in operation, the estimate of materials requirements 
will be prepared by the staff of the production manager. 
After the estimate of materials has been approved by the 
production raanager it will be transmitted to the purchasing 
department, which will make an estimate of the purchases 
which must be made to meet the estimate of materials. 

The foregoing procedure is not always followed. In 
some businesses the production budget is sent to the pur- 
chasing department, and it is required to estimate both the 
materials required and the purchases which are necessary to 
meet these requirements. It is the author's opinion that 
the estimate of materials can best be made by the produc- 
tion department, since it usually has available the informa- 
tion which is necessary for its preparation, or if it does not, 
it can obtain the information easily. It should be evident 
that if the production department, through the planning 
department or otherwise, prepares bills of material for pro- 
duction orders, it must have available data from which it 
can estimate material requirements. If the purchasing de- 
partment collects the data necessary to make this estimate, 
it will usually lead to a duplication of data, the same infor- 
mation being collected and recorded by both the production 
and the purchasing departments. 

In other businesses the production department prepares 
both the estimate of materials and the estimate of pur- 
chases. This procedure leads to equally undesirable results. 



l60 BUDGETARY CONTROL 

The purchasing department must have available for its own 
use the data necessary for the preparation of the estimate 
of purchases ; and if this task is undertaken by the produc- 
tion department, it will be necessary for it to collect dupli- 
cate data which it is not as well qualified to interpret and 
use as is the purchasing department. Furthermore, the 
purchasing department may rightly resent what it regards 
as an undue usurpation of its functions. One of its primary 
functions is to collect data and formulate a purchasing pro- 
gram which will meet the needs of all the departments and 
result in the most profit to the company. If the production 
department prepares the estimate of materials which usually 
constitutes the major part of the purchases made, it is 
depriving the purchasing department of its initiative and 
judgment. 

Materials Budget Form 

As in the case of all other forms used in budgetary con- 
trol, it is not feasible to prescribe a form for the materials 
budget which will satisfy all conditions. The author has 
found the form shown in Figure lo serviceable in most cases. 
The illustration is designed for use when the budget period 
is three months in length. If the period is for a longer period 
of time, further columns may be added. 

In most cases the materials budget will need to be pre- 
pared prior to the beginning of the budget period ; therefore, 
all the information shown on the budget report, including 
the beginning inventory, must be estimated. The estimated 
beginning inventory can be obtained from the budget report 
of the previous period, since the ending inventory of one 
period will be the beginning inventory of the next period. 
The estimated purchases will be based on the estimate of 
materials submitted by the production department, with 
such modifications as the purchasing department may think 



THE MATERIALS BUDGET 



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1 62 BUDGETARY CONTROL 

necessary. For instance, the purchasing department may 
purchase more during the month than called for by the 
materials estimate because the latter amount may not con- 
stitute an economical purchase. The estimated inventory 
at the end of the month is obtained by adding the estimated 
purchases to the beginning inventory, and substracting the 
estimated consumption of materials as shown by the esti- 
mate of materials submitted by the production department. 
If the quantity of purchases and the quantity of materials 
consumed are the same, the beginning and ending inventories 
will be the same. A comparison of the beginning and end- 
ing inventories is of significance to the budget committee, 
since in case of an increase in inventory the purchasing de- 
partment may be asked to explain the cause. 

The estimated disbursements for purchases of previous 
months can be obtained from the unpaid invoice file. The 
accounts payable section of the accounting department may 
be asked to supply this information, since this section main- 
tains the unpaid invoice file. The estimated disbursement 
for purchases of the current month will be determined by 
estimating the time of delivery of the purchases and allow- 
ing for the usual discount period. It can be readily seen 
that the information shown in this column can be only 
approximately correct, but this does not destroy its use- 
fulness, since the purpose of showing the estimated dis- 
bursements on the materials budget is only to indicate, in a 
convenient form for the use of the treasurer and the budget 
committee, the probable financial requirements of the 
contemplated purchasing program. As will be explained 
in the discussion of the financial budget, these estimates 
will be checked and revised, if necessary, by the executive 
in charge of the budgetary procedure and the treasurer in 
the preparation of the monthly estimates of cash receipts 
and disbursements. 



THE MATERIALS BUDGET 163 

After the estimate of material purchases is prepared by 
the purchasing department, it is forwarded to the executive 
in charge of the budget procedure and is transferred by him 
to the budget committee, together with the other depart- 
mental estimates and the estimates of cash receipts and dis- 
bursements which are prepared from the departmental esti- 
mates. After the estimate of materials is approved by the 
budget committee, it is transferred by the executive in 
charge of the budget committee to the purchasing depart- 
ment, whose working program it constitutes for the budget 
period, subject, however, to monthly revisions which may 
be made by the budget committee. 

Control of Materials Budget 

The materials budget, like all other budgets, must be 
checked up at frequent intervals in order that errors in the 
original budget may be detected and corrections made as 
quickly as possible. To make this possible it is necessary to 
have a monthly report which will provide comparisons be- 
tween the estimated and the actual purchases. The report 
illustrated in Figure 1 1 will serve this purpose. 

The purpose and value of the information shown in each 
column of this report should be evident. The executives 
should study this report in the light of the production for the 
month compared with the estimated production. They 
should also give consideration to the comments shown in 
column (8) , since there may be special considerations which 
have brought about a deviation from the materials budget. 
Such deviations should be made as a general rule, however, 
only in response to executive direction or permission. This 
report will be submitted to the executive in charge of the 
budget procedure, and will be transferred by him to the 
budget committee with such recommendations as he may 
think desirable. By a study of this report the budget com- 



1 64 



BUDGETARY CONTROL 



mittee will be able to make such revisions as are necessary 
in the materials budget for the remainder of the budget 
period. These revisions will be communicated to the pur- 
chasing department by the executive in charge of the budget 
procedure. 

It is evident that the budget committee and the treasurer 
will want, in addition to the report shown in Figure ii, a 
report which will show the disbursements for material pur- 
chases during the month compared with the estimated dis- 
bursements for the month. 



CHAPTER XI 
THE LABOR BUDGET 

Need for Estimate of Labor 

After the finished goods which are to be produced during 
the budget period are determined by means of the produc- 
tion budget, it is necessary to estimate the labor required to 
produce these goods. This estimate is necessary in order: 

1. That the personnel department may make plans to have avail- 

able the necessary workmen at the time they are needed in 
production. 

2. That the treasurer may know the probable disbursements re- 

quired by the labor program and can make plans to obtain 
funds for these disbursements. 

3. That the budget committee may be able to see the financial re- 

quirements of the proposed sales and production programs at 
the time they are submitted to it for consideration. The labor 
budget must be combined with the selling expense budget, the 
materials budget, and the other budgets requiring disburse- 
ment of funds, in order to show the total disbursements of the 
budget period, before the budget committee or the board of 
directors can judge the advisability of undertaking the financial 
obligations imposed by the proposed budget program. 

4. The estimate of labor is also required in preparing the "general 

budget" or estimated balance sheet and statement of profit 
and loss. 

It is particularly important that the personnel depart- 
ment have information with reference to the labor require- 
ments considerably in advance of the time when it is neces- 
sary for these requirements to be satisfied. To obtain an 
efficient working force is not an easy task, and capable 
workmen cannot be secured by issuing a purchasing order 
as can materials. If skilled laborers are required, the task 

165 



1 66 BUDGETARY CONTROL 

of supplying them is usually not an easy one. In many 
cases they must be trained before their services can be used 
effectively. A well-organized personnel department will 
gather information of its own accord, which will afford it an 
approximate estimate of the labor requirements, but it does 
not have an approved program on which to work until it 
receives the labor budget. 

Determining Labor Requirements by Analysis of Each Product 

In the same manner in which the production department 
maintains an analysis of each of its products to show the 
manufacturing operations and materials required in its pro- 
duction, it should maintain an analysis which will show the 
labor required in the production of each commodity. If a 
planning department is in operation this analysis will prob- 
ably be maintained by this department, for the analysis is 
necessary for its use in preparing time tickets for distribu- 
tion to the different departments when production orders 
are being scheduled. If this information is not available in 
the planning department, it may be available in the estimat- 
ing department, the pay-roll department, or the personnel 
department. If none of these departments have such 
records, it is necessary that the records be prepared by the 
staff of the production manager. 

By the use of this analysis it is possible to estimate, on 
the basis of the production budget, the labor which will be 
required to produce the goods called for by the production 
program. The preferable way of making this estimate is to 
take each item on the finished goods or production budget 
and determine the amount of labor of each kind which will 
be required to produce it. To illustrate: The production 
budget calls for the manufacture of i ,000 units of articles X 
of Y size. The product analysis shows that article X passes 
through four processes. Process A requires four hours of 



THE LABOR BUDGET ' 167 

labor, process B two hours, process C three hours, and 
process D five hours. It takes, therefore, a total of four- 
teen hours to produce one unit of article X. If 1,000 are to 
be produced it will take a total of 14,000 hours. It is, of 
course, probable that the labor used in the different processes 
will not be of the same grade, in which case the total labor re- 
quired for each process will need to be estimated separately. 
If each item on the production budget is considered in this 
manner, it will be pOvSsible to determine the total labor re- 
quirements of the production program. 

Other Methods of Estimating Labor Requirements 

It is easy to see that this method of determining the 
labor requirements may in some circumstances be quite 
difficult. There may be so many commodities produced 
and so many different kinds of labor may enter into each, 
that it may require an immense amount of clerical work to 
determine the labor requirements of each commodity. 

In some cases it is thought expedient to use the budget 
of machine capacity, discussed in connection with the pro- 
duction budget, as a basis for estimating labor requirements. 
The number of "machine hours" required by the production 
budget having been obtained, an estimate is then made of 
the workmen who will be required to operate these ma- 
chines. In other cases it has been found expedient to 
obtain the ratio between the production volume for several 
periods and the volume of labor of each kind required for 
this production, and apply these ratios to the production 
budget of the current period to obtain the probable labor 
requirements. These estimates will be more accurate if 
separate ratios are determined for the different classes 
of product manufactured. The reason for this is ap- 
parent, for different quantities of labor will be required 
for different classes of finished product, and the ratio 



1 68 BUDGETARY CONTROL 

between the different classes is apt to vary from period 
to period. 

The illustration given on page i6i in connection with the 
discussion of the method of estiraating material require- 
ments is equally applicable to the determination of labor 
requirements. 

In some businesses the estimate of labor requirements 
is made by determining the labor cost per unit of produc- 
tion for several periods, and then applying this unit cost to 
the estimate of production for the current period. For 
instance, it may be determined that the average labor cost 
as shown by the records for several periods is $30 a ton. 
The estimate of production calls for the manufacture of 
1,000 tons; therefore the estimate of labor is $30,000. If 
the unit cost is determined carefully and is calculated sepa- 
rately on each product, an estimate made in this manner 
may serve satisfactorily for purposes of financial control; 
but it does not provide satisfactory information for the use 
of the personnel department. In a business where the vol- 
ume of production is fairly uniform and the working force 
stable, it is not so important that the personnel department 
receive a report showing labor in terms of hours. It must 
always be remembered that the cost of obtaining informa- 
tion must be balanced against its value. Budgetary con- 
trol is no exception to the general rule that profit and loss is 
the ultimate test of the merit of any method of administra- 
tive control. 

Use of Standard Labor Rates 

Some of the most valuable work of industrial engineers 
has been in the establishment of standards by which to judge 
labor. The first work performed by the exponents of "scien- 
tific management" was the establishment of standard time 
limits for the performance of tasks. These rates were first 



THE LABOR BUDGET 169 

established in connection with factory labor and were used 
to speed up production. There seems to be no good reason 
why such standard rates with proper modifications might 
not be applied to all departments of a business and used 
very extensively in the enforcement of administrative con- 
trol. It is interesting to note that a large manufacturing 
firm in the East is now scheduling very definitely its sales- 
men and making a careful study of how each employs his 
time with the intention of developing standards by which 
to judge salesmen's activities. 

Standard labor rates serve three useful purposes: 

1 . They can be used in the estimating of costs and in the establish- 

ment of prices on special orders and contracts. 

2. They serve as a means of judging the efficiency of workmen. If 

the rates are fair and equitable, a workman's efficiency can be 
judged by his ability to reach the standard. In many cases 
his wages are based on the standard, so that he has an incen- 
tive to reach or exceed the standard if possible. 

3. They give important service in estimating labor requirements 

and in formulating a labor program. 

Where standard rates of labor to be used in the man- 
ufacture of each product are established, the task of prepar- 
ing the labor budget is greatly lessened. It must be remem- 
bered, however, that varying conditions may make the 
actual labor cost more or less than the standard, and it is 
the actual as near as it can be estimated which is necessary 
for budgetary control purposes. 

Relation of Labor Requirements to Production and Labor Policies 

The preceding discussion has explained the method of 
determining the amount of labor required to produce the 
amount of goods called for by a production program based 
on a sales program. It might seem from the discussion that 
it is the intention to advocate that the production program 
always fluctuate in harmony with the sales program and 



I70 BUDGETARY CONTROL 

that the labor supply be made to fluctuate with the produc- 
tion program. If this could be done, the determination of 
the labor requirements, once the sales requirements were 
obtained, would be merely a mathematical process. But 
the formulation of a labor program, which is a prerequisite 
to the maintenance of an effective working force, is not so 
simple as this. In the establishment of a labor program it 
is necessary to consider not only the immediate but also the 
long-time labor requirements of a firm. This leads to a 
consideration of both the production and labor policies of 
the firm in question. One or two simple illustrations will 
assist to make this more apparent. 

Previous mention has been made of the fact that the 
production program may not be varied in all cases to cor- 
respond with the fluctuations in the sales program. It may 
be impossible to control the fluctuations in the sales, al- 
though some businesses, notably department stores, have 
done much towards accomplishing this end. But the vol- 
ume of production is under the control of the firm, and 
within the limits of its resources can be varied to suit its 
needs. It may be found more profitable to maintain a 
uniform production, building up during the dull season an 
inventory to meet the excess demands of the rush season, 
than to cause the production program to fluctuate in har- 
mony with the sales program. This procedure may provide 
for a better use of equipment and make possible the main- 
tenance of a more stable and better trained working force. 
If this policy is to be followed it must be kept in mind when 
the personnel department is formulating its labor program. 
It is apparent that the labor program must be based on 
a ''long look ahead" rather than on a "flash-light glimpse" 
of the present condition. 

Some business firms provide homes for the use of their 
workers, charging in many cases a nominal rent for their 



THE LABOR BUDGET 171 

use. In some cases the business is located in a village and 
most of the inhabitants work for the firm ; and in case work- 
men are laid off during dull seasons, it is necessary that they 
journey to another village to obtain work. If they remain 
in the village it is necessary for them to continue to live on 
the property of the firm unless they suffer considerable 
hardship. In many cases the workmen regard the houses 
in which they live as their permanent homes. In fact one 
of the reasons for their being willing to work for the small 
wages they usually receive in these cases is because they 
expect to have a permanent home. In such cases a firm 
may attempt to provide some work for all its employees 
during each month of the year if possible. If necessary, it 
will reduce wages or work the laborers in shifts, so that each 
may work part time, but it will attempt to retain the full 
personnel on the pay-roll, so long as it expects to need them 
for future use. In carrying out this policy, it may pile up 
inventory during dull seasons which will be used during the 
rush seasons. 

In addition, in the formulation of its labor program each 
firm must consider its relations to labor unions, the state 
labor laws, and similar agencies. More than all, it must 
consider its attitude towards its workmen, its welfare pro- 
gram, and the long-run policy it desires to maintain in 
handling its labor force. 

Like any other administrative device, a budget should 
not restrain the management from exercising its legitimate 
functions ; it should only aid the management by providing 
information which will serve as the basis for judgments. 
This is particularly true of the labor budget. 

The Pay-Roll Budget 

The personnel department contracts not only for the 
personnel which is necessary to perform the operations 



172 BUDGETARY CONTROL 

required in the manufacture of the product of the firm, but 
also the personnel which is necessary to perform the supple- 
mentary operations which are required in order that the 
manufacturing operations can be performed. For instance, 
it employs janitors and repair men as well as machine opera- 
tors. In addition it employs personnel for all the other 
departments of the business as well as for the production 
department. 

In consequence of this situation it is the practice of some 
firms to prepare a pay-roll budget which takes the place of 
the labor budget. The pay-roll budget includes an estimate 
of the entire pay-roll of the company. The pay-roll budget 
probably arose from the practice of having the labor budget 
prepared by the pay-roll department. This department 
found it easier to make an estimate of its total pay-roll than 
to analyze it and present separate estimates. 

Reasons Against Employment of Pay-RoU Budget 

It is the opinion of the author that usually this plan is 
not desirable for the following reasons: 

1. It is very apt to lead to inaccurate estimates. It is 
so very easy to add or substract a certain amount from the 
total and report the result as an estimate. The method 
usually results in the employment of ratios between pay- 
roll and volume of business, and such comparisons are un- 
satisfactory because the pay-roll does not fluctuate in pro- 
portion to volume of business. 

2. The pay-roll budget is apt to make difficult an accu- 
rate check on the estimates. If it contains the cost of the 
entire pay-roll of the company, it is difficult to determine the 
cause of the variations between the actual and estimated, 
which are bound to occur. Furthermore, the amounts 
shown on the budget will not correspond with the amounts 
shown in the records, since the pay-roll in the latter is classi- 



THE LABOR BUDGET 1 73 

fied by departments, and in the production department 
direct labor is recorded under labor, while indirect labor is 
recorded as manufacturing expense. 

3. It is desirable to have each functional department 
prepare an estimate of its total expense, including its pay- 
roll. This procedure requires the head of each department 
to consider what his costs have been and what he plans they 
will be in the future. This is one of the important purposes 
of the budgetary program, and the budgetary procedure 
should be designed so as to obtain this result. 

The present chapter is restricted to a consideration of 
the "direct" labor employed in production. ''Indirect" 
labor will be considered in connection with the manufac- 
turing expense budget, and the personnel cost of the func- 
tional departments will be considered in connection with the 
budgets of these departments. 

Preparation of Labor Budget — Approved Procedure 

After the production budget is prepared, the production 
department can prepare an estimate of the labor required 
to produce the goods called for by this budget. If a well- 
developed planning department is in operation, it will have 
available data which will make it possible to prepare this 
estimate without difficulty. In such cases it is customary 
to delegate the preparation of the labor budget to the plan- 
ning department. After it is prepared it is carefully exam- 
ined by the production manager and his staff. If there is 
not a planning department in operation, the estimate of 
labor may be prepared by the staff of the production depart- 
ment, the pay-roll department, or the personnel department. 
In any case it must be approved by the production manager. 

After the estimate of labor requirements is approved by 
the production department, it will be transmitted to the 
personnel department, which will make an estimate of the 



174 BUDGETARY CONTROL 

cost of the labor required. In some cases the personnel de- 
partment makes an estimate of the labor requirements and 
then transmits the estimate to the pay-roll department, 
where the estimated cost is entered. Thereafter the esti- 
mate of labor requirements is returned to the personnel 
department for review. 

Less Satisfactory Methods of Preparing Labor Budget 

The foregoing procedure is not always followed. In 
some businesses the production budget is sent to the per- 
sonnel department, or to the pay-roll department, which 
must estimate both the labor required and the cost of secur- 
ing it. It is the author's opinion that the estimate of labor 
required can best be made by the production department, 
since it usually has available the information necessary for 
its preparation. 

If the personnel department collects the data necessary 
to make this estimate, it will usually lead to a duplication 
of data, since the same information will be collected and 
recorded by both the production and personnel depart- 
ments. It is admitted that some of this information is 
useful and even necessary for the personnel department, 
but it is not necessary to have it in as great detail as is 
required for making the estimate of labor. 

In other businesses the production department prepares 
both the estimate of labor requirements and the estimate of 
labor costs. This procedure leads to equally undesirable 
results. The personnel department must have available 
for its own use the data necessary for the preparation of the 
estimate of labor costs, and if this task is undertaken by the 
production department, it will be necessary for it to collect 
duplicate data which it is not as well qualified to interpret 
and use as is the personnel department. Furthermore, the 
personnel department may rightly resent what it regards 



1 



THE LABOR BUDGET 



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176 BUDGETARY CONTROL 

as an undue usurpation of its functions. One of its primary- 
functions is to collect data on labor requirements and form- 
ulate Ta labor program which will meet the needs of all the 
departments and result in the most profit to the company. 
''Labor program" is here used in a broad sense, and does 
not refer to estimating labor costs only. If the production 
department prepares the estimate of labor cost, it may be 
such as to conflict with the general program of the personnel 
department. 

Form of Labor Budget 

The author has found the form shown in Figure 12 of 
service in the presentation of the labor budget. It can be 
modified to suit the needs of each particular case. This 
form is intended for use in presenting the labor budget to 
the budget committee. The production and personnel de- 
partments will need more detailed reports in preparing the 
estimate. The illustration is designed for use when the 
budget period is three months in length. If the period is 
for a longer period of time, additional columns can be added. 

If the estimate is prepared in this form, it will be possible 
for the budget committee to determine whether the current 
estimates are in excess of past expenditures, and, if so, what 
the cause of the increase is. If this increase is deemed 
unjustifiable, the estimate can be revised accordingly. 
The value of the monthly distribution to the treasurer in the 
preparation of his cash budget is quite evident. 

It may be desirable to show an analysis of the labor costs 
of each department. At least the production and personnel 
departments will employ such an analysis. 

Approval by Budget Committee 

After the estimate of labor is approved by both the pro- 
duction and personnel departments, it will be forwarded to 



THE LABOR BUDGET I 77 

the executive in charge of the budget procedure. He will 
transmit it, with such recommendations as he may think 
necessary, to the budget committee. The latter will con- 
sider it in connection with the other budgets submitted to 
it, and will make revisions if it thinks they are necessary. 
It will return the budget as approved to the executive in 
charge of the budget procedure, who will transmit a copy of 
it to the production and personnel departments. 

Control of Labor Budget 

The labor budget, like all other budgets, must be kept 
under effective control, and this involves the preparation at 
frequent intervals of reports which provide a comparison 
between the actual and estimated performance. It is 
usually desirable to have a monthly report which shows 
these comparisons. A report in the form shown in Figure 
13 will serve this purpose. 

The purpose and value of the information shown in each 
column of this report should be evident. The executives 
should study this report, giving particular attention to the 
effect of any variations in the production program on the 
labor cost. 

This report will be submitted to the executive in charge 
of the budget procedure, and will be transferred by him to 
the budget committee with such recommendations as he 
may think desirable. By a study of this report the budget 
committee will be able to make such revisions as are neces- 
sary in the labor budget for the remainder of the period. 
These revisions will be communicated to the personnel and 
production departments by the executive in charge of the 
budget procedure. 



12 



O CHAPTER XII 
THE WELFARE EXPENSE BUDGET 

Relation of Welfare Expense to Labor Cost 

The preceding chapter has dealt with the method of esti- 
mating and controlling the cost of labor used in manufac- 
turing operations, in so far as that cost is represented by 
the wages paid to workmen. But all firms incur some 
expense in the securing and maintenance of the labor force, 
in addition to the compensation paid to the members of this 
force. This expense for the purpose of budget making may 
be divided into two groups : 

1. "Welfare" expense 

2. Administrative expense of the personnel department 

It is the purpose of the present chapter to treat of the 
first of these, while the second will be discussed in Chapter 
XVIII in the treatment of the expense budgets. It is not 
always easy to make a clear line of demarcation between 
these two classes of expenses, but the following discussion 
will serve to show certain distinguishing features between 
the two. 

Practically all large industrial and mercantile firms now 
place considerable emphasis upon desirable working condi- 
tions for their employees as a basic factor in labor expense 
control. The welfare of the employee is studiously consid- 
ered from the standpoint of his loyalty to the employer as 
well as from the standpoint of his efficiency as a productive 
workman. His health and personal habits have an impor- 
tant bearing also upon his availability for service now and 
in the future as a trained employee. 

178 



THE WELFARE EXPENSE BUDGET 1 79 

Classification of Welfare Expense 

The large corporations, under their welfare plans, incur 
various kinds of expense. Programs for better conditions 
of employment usually include at least medical inspection, 
first-aid medical services, and restrooms for women em- 
ployees. These programs may include any or all of the 
following classes of expense: 

1. Medical inspection 

2. Medical attendance and hospital expense 

3. Payment of wages while on sick leave 

4. Dental inspection and dental work 

5. Inspection of the eyes and fitting of glasses 

6. Picnics, dances, and other entertainments 

7. Night classes in English, civics, arithmetic, and other elemen- 

tary subjects 

8. Tuition in evening schools of commerce 

9. Restrooms 

10. Gymnasiums 

1 1 . Prizes for athletic and literary contests 

12. Lunches free or at cost 

13. Books and magazines, 

14. Contributions to savings fund 

15. Contributions to pension and old-age retirement funds 

The foregoing list is intended to be suggestive of the 
kinds of expenditures which may be incurred in improving 
the working conditions of the employee. It is not the func- 
tion of this discussion to pass judgment on the nature of this 
work or the kind of expenditures which it should include. 
That problem lies in the field of personnel management. 
But granting that certain kinds of expenses exist, it is the 
province of the budgetary program to effect their control. 
It is also unnecessary to enter here into a discussion of the 
title by which these expenses should be known. There are 
some who object to the term "welfare expense" because it 
is thought that it has an improper connotation. From 



l8o BUDGETARY CONTROL 

the viewpoint of our problem the title of this expense is 
immaterial. 

Relation of Welfare Expense to Functional Departments 

The welfare expenses are largely impersonal. The basis' 
for welfare work must be democratic if it is to result in in- 
creased loyalty and self-improvement on the part of the 
average employee. This requirement leads to the opening 
of all the advantages to each employee alike, whether the 
employee is an officer of the company or a machine helper. 
It is sometimes necessary to make exceptions to this rule, 
but they should be as few as possible. All employees alike 
are required to submit to medical inspection, all employees 
alike are given medical service, all are permitted to use the 
gymnasium, and all share in the pension fund, although their 
share may be affected by their previous earning power. 

Because of this impersonal character of practically all 
welfare expense, it is not possible to charge any particular 
item of it as a part of the direct cost of a particular job or as 
a direct charge to the expenses of a particular operating de- 
partment of the business. It may be that more employees 
of the production department avail themselves of the use of 
the bowling alley than employees of the sales department, 
but this does not warrant charging the major part of the 
expenses of maintaining the bowling alley to production 
expense. In most cases the clerical employees will make 
greater use of the books and magazines than will the manual 
laborers ; but so long as the publications are available for the 
use of all the departments, they cannot be treated as an 
expense of any particular department. 

The independent nature of the welfare expense of any of 
the departments is seen also if the purpose of the expense 
is considered. For example, a physical examination of each 
employee may be required to prevent possible poor health 



THE WELFARE EXPENSE BUDGET l8l 

or breakdown of any necessary or trained employee. All 
this is general expense. We cannot say accurately that any 
part of this expense has been incurred for the benefit of a 
particular laborer or even for the benefit of a particular pro- 
ductive unit or operating department. All departments are 
benefited by the maintenance of an efficient working force. 

Again a part of welfare expense is incurred with the idea 
of creating loyalty on the part of the employees towards the 
company. It is desired that they should be stimulated to a 
definite feeling of cooperative interest in their fellow em- 
ployees. Thus, the bowling club prize, awarded by the 
president of the company to the winner of the individual 
high score in the contest open to all employees, is by no 
means to be charged directly to the department where the 
winner is employed. 

The foregoing discussion and illustrations should be 
sufiicient to show that welfare expense is general in nature 
and is seldom particular to any employee or department. 
The welfare expense budget is discussed in connection with 
the several budgets prepared for manufacturing operations, 
because it is in connection with manufacturing industries 
that the administration of personnel has been most difficult 
and the need for w^elfare work has been most felt; but it is 
not intended to imply that this expense is primarily for the 
benefit of the production department. In a manufacturing 
business the bulk of the personnel will usually be in the pro- 
duction department and the greatest fluctuations in the 
number of personnel will also occur here, so that in esti- 
mating the amount of the welfare expense it is necessary 
to give careful consideration to the production program. 

Estimating Welfare Expense — ^Per Capita Cost Method 

Welfare expense will be incurred in the case of any par- 
ticular concern to the extent that the concern finds it profit- 



1 82 BUDGETARY CONTROL 

able to improve its conditions of employment so as (i) to 
compete with other concerns as a place of continuous em- 
ployment, and (2) to improve the efficiency of its workmen. 
A business with a factory located in a country town will not 
find it necessary to incur certain expenses to so great an 
extent as will a business whose factory is located in a con- 
gested tenement district. The former will incur less for 
medical services and in the maintenance of sanitary condi- 
tions. On the other hand, it may find it worth while to 
maintain homes for its employees in order to attract a better 
class of workmen to live in the semi-rural locality, and thus 
incur an expense not common to industrial firms located in 
cities. 

- There is no means by which welfare expense can be de- 
termined exactly. It will vary with the number of employ- 
ees, and will also vary from month to month and year to 
year, given the same number of employees. For in- 
stance, an epidemic may break out at any time which 
will require additional expense for medical inspection and 
service. 

Perhaps the best method of estimating the amounts for a 
budget on welfare expense is to determine the per capita 
cost of each class of expense, and then to multiply the aver- 
age per capita cost of past years by the estimated average 
number of employees for the coming period. If the per 
capita method is employed as a basis for estimating welfare 
expense, it is desirable to have a report showing the amount 
of each class of expense in past years. Then if statistics 
can be had as to the average number of employees in past 
years, the amount of money spent, say, for doctors and 
nurses in 1921, can be divided by the average number of 
employees for 1 92 1 to obtain the per capita expense during 
this year. If it is thought that the same per capita cost 
should be maintained during the year 1922, the per capita 



THE WELFARE EXPENSE BUDGET 1 83 

cost of 1 92 1 will be multiplied by the estimated average 
number of employees for 1922 to obtain the estimated total 
expense for 1922. It will be noticed that by this method it is 
assumed that the expense is for the benefit of all employees 
alike. It would seem that this is proper, since doctors and 
nurses are employed not for the benefit of any particular 
employees, but for the welfare of all as a productive group. 

Points to be Allowed for in Estimating Welfare Expense 

It may be desirable to work out two per capita figures 
for the past year: first, a per capita cost of all employees; 
and second, a per capita cost based on the number of only 
those employees who have been directly benefited by the 
kind of welfare expense under consideration. Thus the per 
capita cost in 1921 for entertainments should be the per 
capita cost for all employees whether or not they have 
attended the entertainments. The per capita cost should 
be figured on the average number of employees, since enter- 
tainments are open to all employees. As a secondary figure, 
it may be useful to have the per capita cost of entertainment 
expense based on the actual number of employees who have 
attended the entertainments. 

If the plant is subject to periodical shut-downs due to 
irregular volume of business, or to seasonal strikes resulting 
from adjustments of wage scales, or for other reasons, it will 
be necessary to distinguish between (i) per capita average 
for continuing expense, such as the salaries of the head sur- 
geon, the head nurse, the librarian, etc., and (2) per capita 
per diem average for all expenses that are incurred only 
during the days of actual plant operation. For example, a 
per capita per diem limitation may be set on free lunches, 
gymnasium operating expenses, and similar expenses which 
are incurred day by day according to the fluctuating num- 
ber of employees. 



1 84 BUDGETARY CONTROL 

It is necessary to use the average number of employees 
in arriving at per capita cost. In any large industrial or 
mercantile business there will be a larger number of individ- 
ual names that have appeared on the pay-rolls during the 
year than the average number continuously employed. 
Thus one man may be employed on a job from January to 
March inclusive, another man from March to August inclu- 
sive, and still another man from September to December 
inclusive. This gives three employees, if we are consider- 
ing the total number of employees actually engaged during 
the year. From the standpoint of the average number of 
employees, these three men constitute only one employee, 
since taken together their services have equaled the serv- 
ices of one man employed continuously throughout the 
year. 

If it is possible to do so, labor turnovers should be figured 
from two different standpoints. First, the turnover of 
labor on account of irregular volume of business should be 
determined. For example, a thousand men may be dis- 
charged in May simply because there is no work for them, 
and a thousand new men may be employed in September, 
because a new volume of work has been obtained. This 
labor turnover is due to irregularity of volume of sales and 
production, and should be distinguished from the labor 
turnover caused by dissatisfaction of employees. 

In estimating the average number of employees for a 
particular year, consideration should first be given to the 
sales program of that year as an index to the labor program 
that will probably result from irregular volume of business. 
The result thus obtained raust be modified by consideration 
of the labor turnover in the year in question, that may pre- 
sumably result from normal dissatisfaction of individual 
employees or from strikes and other manifestations of labor 
unrest. 



THE WELFARE EXPENSE BUDGET 



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1 86 BUDGETARY CONTROL 

Preparation of Welfare Expense Budget 

The control of welfare expense or the expense of condi- 
tions of employment, like the control of any other activity in 
the business, demands first of all that a budget, or estimate, 
or program, or quota, be set up, indicating the plans for 
welfare expense for the coming period. This budget should 
show information for each distinctive class of welfare 
expense. For instance, it may show the welfare expense 
classified under the fifteen headings given on page 179. In 
form the welfare expense budget may be as shown in Figure 
14. The purpose of each of the column headings is apparent. 

The welfare expense budget should be prepared by the 
personnel department. It should be based on the general 
plans of the business as shown by its various departmental 
estimates, and should be in harmony with the general poli- 
cies which have been adopted by the company. The per- 
sonnel manager should discuss with the budget committee 
prior to the preparation of the estimate of welfare expense, 
any new plans which he desires to inaugurate, so that he 
may have the benefit of the judgment of the principal execu- 
tives of the company in its preparation. 

The personnel manager will transmit the welfare budget 
with his approval to the executive in charge of the budget 
procedure. The latter will transmit it to the budget com- 
mittee with any comments he thinks necessary. The 
budget committee will make any revisions which it may 
think are required and return the budget, with its approval, 
to the executive in charge of the budget procedure. The 
latter will return it to the personnel manager. 

Control of Welfare Expense Budget 

The budget on welfare expense is effective only if a 
monthly report is prepared, showing the information given 
in the seven columns of the welfare budget contrasted with 



THE WELFARE EXPENSE BUDGET 1 87 

actual number of employees reported, and actual amount of 
expense for each class of welfare expense, and actual per 
capita cost. This report may be made in the form shown 
in Figure 15. 

It is quite likely that the actual per capita will vary to a 
considerable degree from the estimated per capita, but the 
budget report does furnish a basis for planning welfare 
expense and also offers the means whereby the management 
responsible for welfare expense can keep such expense 
within reasonable control. 

The monthly report will be submitted by the executive 
in charge of the budget procedure to the budget committee, 
and the latter may, if it thinks this report shows the neces- 
sity, make revisions in the welfare expense budget. The 
executive in charge of the budget procedure will communi- 
cate these changes to the personnel manager. 



CHAPTER XIII 
THE MANUFACTURING EXPENSE BUDGET 

Need for Estimate of Manufacturing Expense 

After the finished goods which are to be produced during 
the budget period are determined by means of the pro- 
duction budget, it is necessary to estimate the manufactur- 
ing expenses which are necessary to produce these goods. 
This estimate is necessary in order — 

1 . That the various departments which are responsible for securing 

the "services" which compose manufacturing expense, may 
make plans to have these services by the time they are 
needed in production. The nature of these services and the 
departments responsible for their procurement will be explained 
later in this chapter. 

2. That the treasurer may know the probable disbursements re- 

quired by the manufacturing expense program and can plan 
to obtain the funds needed for these disbursements. 

3. That standard rates for manufacturing expense may be estab- 

lished more accurately. The method of establishing such 
rates is discussed later. 

4. That the budget committee and the board of directors may be 

able to see the financial requirements of the proposed sales 
and production programs at the time they are submitted for 
consideration, and that they may see the effect of the manu- 
facturing expense cost on the estimated financial statements. 
In addition they should be able to see the relation of the 
volume of production to the manufacturing expense. The 
significance of this relationship will be explained later in the 
chapter. 

The reader will notice that the estimate of manufactur- 
ing expense combined with the estimate of labor and the 
estimate of materials constitutes the estimated cost of 



THE MANUFACTURING EXPENSE BUDGET 189 

the manufactured product, since the elements of manu- 
facturing cost are materials, labor, and manufacturing 
expense. 

Definition of Manufacturing Expense 

The costs incurred in the production of the finished 
product are divided into two broad classes, "direct" costs 
and "indirect" costs. 

Direct costs are payments or charges for labor and material 
expended upon a definitely determined unit or product. Small 
costs, however, are not charged directly to the product, even when 
the latter can be determined, unless the increased accuracy of the 
records justifies the clerical work entailed. It follows, therefore, 
that indirect costs are those which cannot be charged economically 
or directly to the product. An example of a direct cost is the cost 
of the raw material in a chair. Indirect costs arise from the fol- 
lowing sources : 

1. Indirect material — good examples of which are rags used to 

wipe off chairs and tools; or new tools used to replace those 
discarded. 

2. Indirect labor — for instance, wages of foremen who super- 

vise the employees in several departments where chairs are 
made. 

3. Fixed charges — depreciation, taxes, insurance, etc. 

Adherence to the above cost classification adds to the accuracy 
of the records for this reason: By cjiarging items directly to the 
cost units (when economical), the remaining costs (indirect costs) 
are less than if certain items legitimately "direct" were treated as 
indirect costs. Indirect costs are distributed over the product in 
as accurate a manner as possible, but such charging is less accurate 
than direct charging. For instance, raw material can be accurately 
measured and charged directly against the chair. The depreciation 
of the equipment used in manufacturing the chair cannot be deter- 
mined with any measuring device. It must be estimated. Con- 
sequently the total depreciation of equipment is distributed over all 
units of product (chairs) made. Any charging, therefore, which 
reduces the distributable costs, thereby" increases automatically the 



190 BUDGETARY CONTROL 

accuracy of the cost records. The growing observance of the princi- 
ple of direct — that is to say correct — charging has done much to 
improve the exactness of cost accounting.^ 

It is the purpose of the present chapter to treat under 
the heading of "manufacturing expenses" the items termed 
"indirect costs" in the foregoing quotation. "Indirect 
expenses," "burden," and "overhead" are other terms by 
which these expenses are known. 

Components of Manufacturing Expense 

The items which compose manufacturing expense will 
vary in different businesses, depending on the nature of 
their operations. The following are those which appear in 
mo«t cases: 



I. 


Indirect material 


8. 


Maintenance 


2. 


Supplies 


9- 


Depreciation 


3- 


Indirect labor 


10. 


Power 


4- 


Supervision 


II. 


Heat and light 


5- 


Inspection 


12. 


Small tools 


6. 


Experimental work 


13- 


Taxes 


7- 


Repairs 


14. 


Insurance 



The foregoing items are sufficient to indicate the nature 
of those which generally compose manufacturing expense. 
The reader can probably supply other items of manufactur- 
ing expense from his experience. Some accountants would 
combine such items as "indirect labor," "supervision," and 
"inspection." From the viewpoint of estimating their 
amount, it is desirable to have them separate. 

Classification of Manufacturing Expense 

It is usually desirable that manufacturing expense be 
classified by departments and that subclassifications be 
maintained for each department. Detailed departmental 

1 Jordan and Harris, Cost Accounting, page 23. 



THE MANUFACTURING EXPENSE BUDGET igi 

classifications are necessary as a basis for effective control. 
The departmental classification makes possible the fixing 
of responsibility, and the classification within the depart- 
ment makes possible the meeting of the responsibility. It 
also affords a more comprehensive basis for judging the 
success with which the responsibility has been met. 

To illustrate concretely, the X Manufacturing Company 
has four departments and manufactures one commodity. 
In 1 91 8 the unit cost of the commodity was $12, while in 
191 9 it was $15. In attempting to find the cause of the 
increase, the first analysis will be to determine how much 
of the total cost is material cost, how much is labor cost, 
and how much is manufacturing expense. This analysis 
shows that the manufacturing expense per unit was $3 in 
191 8, and $4 in 1919. An analysis of the cost of manu- 
facturing expense by departments for the two years shows 
the following: 

Year 

1918 

1919 



Dept. A 


Dept. B 


Dept. C 


Dept. D 


$.80 


$.90 


$.60 


$.70 


1.20 


•95 


•65 


1.20 



This analysis shows that the principal increases in 
manufacturing expenses are in Departments A and D. 
The responsibility for the increase is fixed on specific de- 
partments, but it is now necessary to determine whether 
the increase is due to inefiiciency of the departmental heads 
or to causes over which they had no control. To ascertain 
this, it is necessary to examine the analysis provided by 
the departmental accounts. 

This examination shows that in Departments A and D 
a large amount of miscellaneous supplies and indirect labor 
is necessary. Owing to the increase in the price of supplies 
and labor during the year 1919, the manufacturing expense 
of these departments was increased. If it is shown that 



192 BUDGETARY CONTROL 

approximately the same quantity of supplies and labor was 
used as previously but its price had greatly increased, the 
departmental foreman cannot be held responsible. If, on 
the other hand, it is found that the increase in manufactur- 
ing expense in these departments was due to the use of an 
increased quantity of supplies and labor per unit of product, 
there is then circumstantial evidence of inefficiency on the 
part of the departmental foreman, and he should be re- 
quired to show cause for the condition. This simple 
illustration serves to show the necessity for a detailed 
analysis of the expenses of each major group if responsi- 
bility is to be fixed and variations explained. 

A proper classification of expenses is of importance both 
from the viewpoint of accounting records and budget reports. 

Determination of Manufacturing Expense Requirements 

The estimate of manufacturing expense, like the esti- 
mate of materials and of labor, is based on the estimate of 
production. It is somewhat more difficult to correlate the 
manufacturing expenses with the production, than it is to 
correlate materials and labor with production. This is 
due to two reasons: 

I. The various items which go to make up the manu- 
facturing expenses are secured from various sources and 
their procurement is not centralized under one individual, 
like materials and labor. For instance, the indirect mate- 
rial is obtained by the purchasing agent, the indirect labor 
by the personnel department, the taxes are paid by the 
treasurer, the repairs made by the maintenance depart- 
ment, and so on. This lack of centralized responsibility 
makes it difficult to fix the duty for the preparation of the 
manufacturing expense budget on those who are responsible 
for the expenditures which result in the procurement of the 
"services" of which it is composed. 



THE MANUFACTURING EXPENSE BUDGET I93 

2. Manufacturing expenses do not vary as a rule in 
proportion to the variation in production. Usually they 
do not increase or decrease as rapidly as production. This 
Is due to the fact that there are "fixed" charges which 
are affected little if at all by the volume of production. 
For instance, taxes and insurance on machinery will be 
the same whether the machine is run at full or half capacity. 
There are other charges such as depreciation and supervi- 
sion which will be affected by the volume of production 
but not in proportion. If production is sufficient to em- 
ploy ten men in a department, it is necessary to have a 
foreman, and the same foreman may be able to supervise 
properly twenty men when production increases to the 
point where they are needed. Because of this condition 
it is impossible to estimate manufacturing expenses in lump 
by means of the ratio between manufacturing expense and 
production, if the production varies from one budget period 
to another. 

The cost accounting department is the one place where 
all the items of manufacturing expense are shown. Its 
records show what the manufacturing expenses of the 
past periods have been and it is possible for it to prepare 
on the basis of these records an estimate of what the manu- 
facturing expenses will be. The estimate, of course, must 
take into consideration the production program for the 
period as shown by the estiniate of production. To do this 
properly the cost department should classify the manu- 
facturing expenses as "fixed" and "variable." These 
terms must be used with caution, for there are few if any 
expenses which may be literally termed as "fixed." If 
this classification is made, it will not be difficult to estimate 
the fixed charges, but very careful attention must be given 
to the effect of the production volume on the variable 
charges. 

13 



194 BUDGETARY CONTROL 

It tends to simplicity and economy to have the estimate 
of manufacturing expense prepared by the cost accounting 
department. The chief objection to this procedure is that 
this department is apt to place too much emphasis on the 
statistics of past performance and too little emphasis on 
the contemplated performance. One method of correcting 
this difficulty is to have the cost department classify its 
estimate so as to show the expenses to be incurred by each 
unit or department, and then have each unit or department 
approve that part of the estimate for which it is responsible. 
For instance, the purchasing department could approve the 
estimate on indirect materials, the personnel department 
the estimate on indirect labor, the treasurer the estimate on 
taxes and insurance, and so on. 

It is, of course, possible to have each separate unit or 
department make an estimate of that part of the manu- 
facturing expense for which it is responsible, and then 
have these combined to make up the complete estimate. 
The separate estimates may be checked against the ac- 
counting records to test their accuracy. This method 
requires a great amount of care in getting the necessary 
information needed by each department for making its 
estimate and in seeing to it that each prepares the estimate 
properly. When it is possible to do so, there are decided 
advantages in having the estimate of manufacturing ex- 
pense prepared by the staff of the production department, 
since this department is responsible for its enforcement. 
The only disadvantage of this procedure is that this 
department often does not have the data to make possible 
the preparation of an accurate estimate. 

Distribution of Manufacturing Expenses 

One of the most difficult problems with which engineers 
and accountants have had to deal in the attempt to as- 



THE MANUFACTURING EXPENSE BUDGET I95 

certain costs of manufactured product, is the allocation of 
the manufacturing expenses to the various classes or units 
of product. This problem gives rise to two questions: 

1. What expenses should be allocated to the product? 

2. What method should be employed in allocating these expenses? 

For many years accountants as a whole assumed that 
all manufacturing expenses should be allocated to the 
product and therefore gave their undivided attention to the 
answering of the second question. 

A number of methods of allocating manufacturing ex- 
penses were developed. These ranged from the simple 
method of using a percentage on direct labor cost, to the 
complex method of using a machine rate plus the ' ' supple- 
mentary" rate. The reader is doubtless familiar with 
these various methods since they have been well explained 
in many texts on cost accounting and articles in magazines.^ 

The purpose of all these methods as originally developed 
is to allocate as accurately as possible all the manufacturing 
expenses of a period to the goods produced during that 
period. During recent years engineers and accountants 
have come to realize that it may not be desirable to allocate 
all the manufacturing expenses to the product produced. 
No doubt they were first led to see this by the fact that if 
all expenses during a period of depression are charged to 
the product produced during that period, the cost of the 
product is exorbitant. It is easy to see that if a plant is 
running at 60 per cent capacity and all the fixed charges 
of the plant are allocated against the 60 per cent of normal 
production, the costs will be greatly increased. If these 
costs are used as a basis for establishing sales prices, the 

2 Those readers who may desire a discussion of the various methods of distributing overhead 
may well read one or more of the following: Jordan and Harris, Cost Accounting; Nicholson 
and Rohrbach, Cost Accounting; Scoville, Cost Accounting and Burden Application; Eggleston 
and Robinson, Business Costs; Church, Manufacturing Accounts and Costs. 



196 BUDGETARY CONTROL 

competitors are very apt to get the business; and as sales 
fall off there will be a further decrease in production with a 
further increase in cost, with the consequent increase in 
sales price, which results in a decrease in sales, and so on 
around the circle. 

Faced by this situation, accountants and engineers real- 
ized the necessity of developing some method of handling 
manufacturing expenses which would prevent the charging 
to product of expenses which were not the result of the 
production of this product. To this end, predetermined or 
standard rates were established by which the product was 
charged only with the same amount of expenses which it 
would have been charged if the plant was running at its 
normal capacity. In the establishment of normal capacity 
the production of past years when the plant was operating 
under what was thought to be normal conditions was taken 
as a basis. The manufacturing expense not absorbed by 
the standard rates was charged direct to the profit and loss 
account. Those who are interested in the historical de- 
velopment of the use of the standard rate will be interested 
in reading pages 397-399, ''Cost Accounting," by Jordan 
and Harris. 

Relation of Standard Rates to Manufacturing Expense Budget 

From the viewpoint of administration, the importance 
of the standard rates for manufacturing expense is obvious. 
These standard rates may also be of considerable significance 
from the viewpoint of budgetary control. It has been 
pointed out in the discussion of materials and labor, that 
if standard rates have been set, it is only necessary to 
multiply these by the quantity of finished goods called 
for by the production budget to obtain the estimate of 
materials or estimate of labor. If standard expense rates 
have been set, a similar procedure may be followed in pre- 



THE IMANUFACTURING EXPENSE BUDGET 197 

paring the estimate of manufacturing expense. The 
standard expense rate for each product may be multiplied 
by the quantity of this product called for in the production 
budget in order to obtain the estimated manufacturing 
expense. If the product passes through two or more de- 
partments, it will probably be necessary to use a different 
rate for each department. It is obvious that the actual 
expenses may be greater or less than the standard, and this 
variation must be given consideration in preparing the 
estimated statement of profit and loss and the financial 
budget. 

One objection to this method from the viewpoint of 
administrative control, is that if the production varies in 
quantity, the standard rate should be made to vary also. 
In the establishment of standard costs it has been the 
practice of accountants to select one or more periods during 
which they think there has been normal production, and 
use the costs of these periods as standard costs, or at least 
to regard the production of these periods as standard pro- 
duction and determine the standard costs on the basis of 
the quantity of production. For the purpose of distribut- 
ing the costs of production evenly over all periods and 
thereby determining a uniform cost, there is decided merit 
in this method. It would seem, however, from the view- 
point of administrative control, that it would be much 
more accurate to have the standard costs based on the 
anticipated production of the period under consideration. 

The manufacturer does not care so much to know how 
his costs compare with what they should be if he produced 
the quantity which he produced during some previous 
period, as he desires to know: 

I. At the beginning of the period, what his costs will be if he 
manufactures what he plans to manufacture during the 
period. 



198 BUDGETARY CONTROL 

2. During the period, how his actual costs compare with what he 

estimated they would be. 

3. At the end of the period, why there is a variation between the 

estimated and the actual, if such a variation exists. 

It is not intended to imply that the use of standard rates 
as a means of equaHzing costs may not be desirable, but 
only to emphasize that standard costs based on past pro- 
duction may not give the manufacturer the information 
he most needs in judging the desirability of contemplated 
plans or of controlling these plans after they are put into 
operation. 

Relation of Budget Program to Standard Rates 

If the manufacturing expenses are allocated by means 
of the "machine rate," the estimated activity of the plant 
can be given effect in the establishment of the standard 
machine rates. Mr. E. O. Sommer in Industrial Manage- 
ment, January, 1920, discusses one method by which this is 
done in the following quotation: 

The object in establishing a machine hour rate is to determine 
the cost of running a machine one hour. This can be done by: 

1 . Classifying and dividing the machines into units of like opera- 

tion. 

2. Estimating the percentage of activity at which the plant is 

expected to operate. 

3. Determining the operating expenses of each unit for a given 

period. 

In classifying machines, the department may be taken as a unit 
if all the machines perform the same operation; should, however, the 
department include machines of unlike operation, we shall have to 
go a step further and subdivide the department into various 
machine groups, each machine in a group performing the same 
operation. This subdivision may lead us so far as to consider a 
single machine as a unit. 

Thus, having classified the processing machines of the plant 
into units, our concern is to collect all expenses which will be incurred 



THE MANUFACTURING EXPENSE BUDGET 199 

in the operation of these individual units during a given period. 
These expenses we may place into two main groups: 

1. Comprising such items as can be directly charged against 

certain units, as labor, floor space, current repairs, etc., 
necessary for the operation of that unit. 

2. Representing indirect expenses, which although they are 

largely direct charges against the department, still cannot be 
allocated to individual units, but are to be prorated on a suit- 
able basis. 

The percentage of activity, the third factor in the calculation 
of predetermined rates, must be estimated with utmost care. If 
we could assume that the plant will be able to work at and maintain 
a 100 per cent activity, our task of calculating an hourly rate would 
be a simple one. We would obviously divide the total working 
hours of the week, or month, or year, into the total operating cost 
for that period and arrive at a cost per hour. 

Since, however, an activity of 100 per cent can hardly be realized, 
a method must be found to ascertain the highest possible percentage 
of activity (budget activity) at which the management may expect 
to keep the plant working. 

Should the statement reveal that the plant will not be kept 
operating at full capacity it will be the problem of the management 
to investigate the cause of this condition and to find a way to bring 
the activity to a normal level. Overequipment, decrease in the 
demand for the product, or competition may account for reduced 
activity. 

Many expenses, as rent, depreciation, etc., accrue as time goes 
on whether the machine be active or idle, and the cost per hour will 
naturally increase in the same proportion as the activity decreases. 
To illustrate this, let us assume that these fixed overhead expenses 
for a group of machines be $2,400 per year. Taking the year at 50 
weeks of 48 hours each, or 2,400 working hours, the overhead would 
be, at 100 per cent activity, $2,400 for 2,400 hours — $1 per hour; at 
90 per cent activity, $2,400 for 2,160 hours — $1.11 per hour; at 85 
per cent activity, $2,400 for 2,040 hours — $1.18 per hour. 

Should the budget activity for the ensuing period be 90 per cent, 
it would be a serious error to distribute the operation cost on a 
basis of 100 per cent activity. 

Assume for example that the budget rate has been based on a 



200 BUDGETARY CONTROL 

90 per cent activity and assume further that the actual activity 
during a period be 90 per cent, all expenses then will be gradually 
charged to the process, and the debit and credit side of the operating 
account of this particular machine group will be in balance. 

Should, however, the actual activity fall below the percentage 
used in the calculation of the machine rate (budget rate), there would 
remain in the operating account a balance of undistributed ex- 
penses. This balance, which is due to curtailed production, 
should not be debited to the production account either directly or 
by increasing the budget rate, but be charged to profits. Any 
increase over the budget activity would result in a credit balance 
on the operation account and be a credit to profit and loss. 

If a comparison of the actual and budget figures of the individual 
cost factors should reveal that a fluctuation is due to change in 
prices, a revision of the budget will be necessary and a new rate 
must be determined. 

A difference between the actual and budget activity would 
indicate either an increase or decrease in the production. Since a 
loss or gain due to fluctuations in the activity does not result from 
the manner of operating a unit, any difference due to this cause 
should be eliminated from the operation account. 

This can be accomplished best by calculating an "idle time" 
and "overtime" rate, which will represent the hourly cost of all 
those charges which are incurred regardless of whether the machine 
group is active or idle. We shall credit the operation account at 
the "idle time" rate for the total idle hours in the budget period, 
and charge an account called " Idle and Overtime." Inversely, we 
shall debit the operation on account at the "overtime" rate for 
the total active hours in excess of the budget hours, and credit the 
"Idle and Overtime" account. A balance, left in this account at 
the end of the budget period, which will then either show a loss due 
to curtailed production or a gain due to increased activity, is closed 
into the sales account. 

The author does not intend to endorse the general 
appHcation of the particular method described in this 
quotation, but the general principle it illustrates, that 
standard rates should be related to the budget program, is 
worth emphasis, 



THE MANUFACTURING EXPENSE BUDGET 201 

Relation of Standard Rates to Volume of Production 

It should of course be understood that in the setting of 
standard rates based on estimated activity as explained in 
the foregoing quotation, only the expenses which are prop- 
erly applicable to the estimated production should be 
included. 

To accomplish this end the following procedure is neces- 
sary: 

1. Determine the "normal" production of the plant. This of 

course cannot be established with exactness. Generally speak- 
ing, the normal production is that which would be accomplished 
if the plant was operating so that the equipment as a whole 
would be used at the greatest efficiency, at which it can reason- 
ably he expected to be used. Normal production is usually 
less than the maximum production. In determining normal 
production, all parts of the equipment must be given careful 
consideration. The old adage that "a chain is no stronger 
than its weakest link" is approximately true of the equipment 
of a plant. For instance, the melting department of a foundry 
may be able to turn out sufficient melt to produce loo tons 
of castings during a certain period, but if the moulding floor 
is only large enough to make possible the moulding of 75 tons, 
the normal capacity of foundry cannot exceed 75 tons. 

2. Determine the manufacturing expenses which would be incurred 

if the factory operated at normal capacity. 

3. Determine the estimated production under the budget program 

for the current period. 

4. Determine the ratio of (3) to (i) and apply this ratio to (2), to 

obtain the manufacturing expenses applicable to the current 
period. Judgment will have to be used in doing this because 
of the changing price level and other factors which may necessi- 
tate modifications of this mathematical result. 

5. On the basis of the result obtained in (4) and the estimated 

activity of the current period, establish standard machine rates. 
There is a difference of opinion as to what should be included 
in the establishment of machine rates. It is not worth while 
to enter into this discussion here, 



202 BUDGETARY CONTROL 

Modification of the Standard Machine Rate Plan 

The author fully realizes that there are many businesses 
which will find it impracticable to follow the plan for estab- 
lishing standard expense rates which has been outlined in 
the foregoing discussion. Many manufacturing firms do 
not find it expedient to establish machine rates at all. 
Nevertheless the general principles developed by the fore- 
going are applicable to all manufacturing firms, namely: 

1. That the product of each period should be charged only with 

the manufacturing expenses which contribute to its production, 
and should not be burdened with the expenses arising from 
unused capacity or idle time. 

2. That a standard rate for charging the expense to the product 

should be established and that the undistributed burden should 
be charged directly to profit and loss. In case of production 
above the normal, the excess should be credited to profit and 
loss. 

These principles can be applied regardless of the method 
employed in the distribution of manufacturing expenses. 

The * 'Miscellaneous" Expense Budget 

In the discussion of the materials budget it was explained 
that some businesses prepare a "stores" budget which in- 
cludes both direct and indirect material, and in the discussion 
of the labor budget it has been explained that sometimes a 
"pay-roll" budget is prepared which includes both direct 
and indirect labor. When this procedure is followed, two 
of the large items of manufacturing expense are eliminated 
from the manufacturing expense budget. In this case 
there may be prepared a "miscellaneous" expense budget 
which will include all the expenses other than indirect labor 
and indirect material. 

It is easier to prepare the miscellaneous expense budget 
and to have the indirect materials and labor included in the 



THE MANUFACTURING EXPENSE BUDGET 203 

stores and pay-roll budget respectively. But it is doubtful 
if this method gives as effective control of manufacturing 
expenses. It is desirable that all manufacturing expense 
be shown as a total and that standards be set up by which 
to judge its amount. It is of course possible to set up these 
standards independent of the budgets, but it is much more 
effective if they are correlated so that each will check the 
other. It is emphasized throughout this book that the 
budgets should be prepared in terms of "units of responsi- 
bility." The production department is responsible for all 
the manufacturing expense and it is better that its total 
amount be shown in one budget — the manufacturing expense 
budget. 

It is admitted that this procedure necessitates the 
purchasing agent to make up an estimate of purchases for 
the indirect materials included in the manufacturing expense 
budget. Obviously the purchases of these materials will 
not correspond with their consumption, and it is the latter 
which is shown on the manufacturing expense budget. In 
some cases the purchasing agent may find it necessary, in 
order to secure an economical purchase, to buy at one 
time sufficient to last for a considerable number of 
periods. 

For the purpose of the financial budget it is the disburse- 
ments which are desired, but for the purpose of the esti- 
mated balance sheet and estimated statement of profit and 
loss the consumption is necessary. It is thought best, 
therefore, to have the composite budget for manufacturing 
expenses prepared, and to support this with the estimate of 
purchases with the consequent disbursements. 

Preparation of the Manufacturing Expense Budget 

The method of preparing this budget has been indicated 
by the preceding discussion. If it is assumed that the 



204 



BUDGETARY CONTROL 



original estimate of manufacturing expense is prepared by 
the cost accounting department, a copy of it will be sent 
by this department to each department responsible for 
incurring expenditures under it. Each of these depart- 
ments will indicate any changes which it thinks necessary, 
and return the estimate with its approval to the cost de- 
partment. The purchasing agent will attach to the esti- 
mate of the cost department an estimate of purchases of 
materials which are necessary to supply the indirect mate- 
rials called for by the program. 

The cost accounting department will prepare an esti- 
mate for submission to the executive in charge of budgetary 
procedure. On this estimate it will give effect to the 
revisions which have been made by the various depart- 
ments. If it does not approve of these revisions, it will 
show both its estimates and the revisions, and make such 
comments as it thinks appropriate. 

If the original estimate is prepared by the production 
department, it will follow the same procedure as outlined 
above for the cost department. As previously explained, 
it is desirable that the estimate be prepared by the produc- 
tion staff, but it is more frequently prepared by the cost 
department. 

The executive in charge of budgetary procedure will 
transmit the estimate received from the cost accounting 
department or the production department to the budget 
committee. He may accompany it with such comments 
as he thinks appropriate. The budget committee will 
consider the estimate of manufacturing expense in con- 
nection with all the other estimates which it receives at the 
same time, and will make any revisions it deems necessary. 
It will transmit the estimate as approved to the executive 
in charge of the budget procedure, who will transfer a copy 
of it to each of the departments which are interested in its 



THE MANUFACTURING EXPENSE BUDGET 



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206 BUDGETARY CONTROL 

enforcement. In form the manufacturing expense budget 
may be made as shown in Figure i6. 

Control of Manufacturing Expense Budget 

The cost accounting department will prepare monthly 
reports showing a comparison between the actual and 
estimated manufacturing expense. This report may be in 
the form shown in Figure 17. The columnar headings on 
this report are self-explanatory. 

This report will be submitted to the executive in charge 
of the budget procedure and will be transferred by him to 
the budget committee. The committee will study this 
report in connection with the other monthly reports, and 
will make any revisions in the manufacturing expense budget 
which it thinks are necessary as indicated by the reports. 
Any changes it makes will be transmitted to the departments 
concerned by the executive in charge of the budgetary 
procedure. 

In addition to the general report on the budget as a 
whole, there should be prepared a separate report for each 
department in the factory, showing a comparison between 
the actual and standard performance. In case the general 
report shows a wide variation between the actual and the 
estimated expenditures, these detailed reports will provide 
information which the executive in charge of the budget 
procedure can use in explaining these variations to the 
budget committee. 

Review and Summary of Production Control 

In Chapters IX to XIII, inclusive, an attempt has 
been made to outhne the procedure necessary to effect a 
coordination of sales and production, and to prepare and 
execute a production program. Previously in Chapters 
V and VI the method by which the sales requirements 



THE MANUFACTURING EXPENSE BUDGET 207 

are determined has been explained. In summary form 
the procedure discussed in these chapters may be outlined 
as follows : 

I. Preparation of Sales Budget 

1. Estimates prepared by sales units. 

2. Revised by general sales office. 

3. Revised by the production department in the light of production 

possibilities and desirabilities. 

4. Revised by the controller or other officer in the light of profit 

possibilities. 

5. Forwarded to the budget committee for final revision and 

approval. 

II. Preparation of "Production" Budgets 

1. Finished Goods Budget: 

(a) Estimate of finished goods requirements prepared by the 

production department from the sales estimates. 

(b) Revision and approval of finished goods estimates by the 

budget committee. 

(c) Enforcement of this budget through the means of the 

balanoe of stores records operated under maximum and 
minimum standards. 

2. Materials Budget: 

(a) Estimate of materials requirements prepared from the 

finished goods estimate by the production department 
(the duty of preparing this estimate is usually delegated 
by the head of the production department to the 
planning department). 

(b) Estimate of material requirements, after approval by 

the head of the production department, is transmitted 
to the purchasing department and this department 
prepares an estimate of the material purchases required 
and the disbursements resulting therefrom. 

(c) Estimate of materials and purchases revised and approved 

by the budget committee. 

(d) Enforcement of materials budget through the means of 

the materials balance of stores records operated under 
maximum and minimum standards. 



208 BUDGETARY CONTROL 

3. Labor Budget: 

(a) Estimate of labor requirements prepared from the finished 

goods budget by the production department (the duty 
of preparing this estimate is usually delegated by the 
head of the production department to the planning 
department). 

(b) Estimate of labor requirements, after approval by the 

head of the production department, is transmitted to 
the personnel department and this department makes 
an estimate of the cost of supplying this labor. 

(c) Estimate of labor requirements and labor cost revised 

and approved by the budget committee. 

(d) Enforcement of the labor budget by the production 

department with the assistance of the personnel de- 
partment, through the agency of a centralized produc- 
tion control system. 

4. Manufacturing Expense Budget: 

(a) Estimate of manufacturing expense requirements made 

by cost accounting department or production depart- 
ment. 

(b) Estimate of manufacturing expense requirements ap- 

proved by the production manager and the head of 
the various departments responsible for the incurrence 
of the expenditures for which it provides. 

(c) Estimate as approved in (b) transmitted to budget com- 

mittee for revision and approval. 

(d) Enforcement of the estimate by the production de- 

partment through the agency of a centralized control 
system. 

III. Monthly Reports for Control and Revision of Budgets 

1. Report on finished stock budget as shown in Figure 8 (page 141). 

2. Report on materials budget as shown in Figure 11 (page 161). 

3. Report on labor budget as shown in Figure 13 (page 175). 

4. Report on manufacturing expense budget as shown in Figure 17 
(page 205). 

IV. Monthly Revision of Budgets 

I . Budget committee receives monthly reports on all departmental 
estimates, including those outlined under (III). 



THE MANUFACTURING EXPENSE BUDGET 209 

2. The committee considers these reports with reference to their 

relation to each other and makes such revisions as are deemed 
necessary. 

3. Any revisions made in the budgets outhned in (II) will be com- 

municated to the production department and the other de- 
partments concerned. 

It should be understood that the procedure given in 
this outHne is intended to be suggestive and not arbitrary. 
Each firm must adopt a procedure to fit its particular needs. 
It is thought that if the foregoing procedure is understood 
properly, it will not be difficult to make the adaptations 
required in any particular case. 



14 



CHAPTER XIV 
THE PURCHASES BUDGET 

Relation of Purchases Budget to the Sales Budget 

In the preceding chapters considerable attention has 
been given to the method by which the manufacturer plans 
a production program which will result in a proper coordi- 
nation between production and sales. But the merchant 
has a similar problem of coordination, which he can solve 
only by formulating a purchasing program which will per- 
form the same function for him as the production program 
performs for the manufacturer. 

The amount of goods which is to be purchased by a 
merchant is determined primarily by his estimate of future 
sales. Goods are purchased only to be sold, and sales can 
be consummated only when goods are available for sale. 
The general manager of a mercantile store is charged with a 
double responsibility. He must maintain such stocks of 
goods as will enable the store to fill customers ' orders, and 
at the same time he must avoid the accumulation of stock 
beyond the sales demands, as such excessive accumulation 
results in loss from tied up capital, and probably also from 
the obsolescence and deterioration of the merchandise. 

The general manager can meet this responsibility only 
by anticipating sales demands and setting up as nearly as 
possible a schedule of deliveries to stock which will satisfy 
but not exceed these demands. 

In merchandise planning, therefore, the first step is the 
determining of the amount of future sales; the second step 
is the determining of the purchases necessary to meet these 
sales; and the third step is the setting up of a purchasing 
program which will coordinate the deliveries of purchases 

210 



THE PURCHASES BUDGET 211 

with the sales deUveries required by the sales program. 
The first step has been previously discussed. The second 
and third will be dealt with in this chapter. 

Determination of Purchases Requirements 

The ideal purchases program, from the viewpoint of the 
economical use of capital, would be one which provided for 
the delivery to stock each day of the exact amount of mer- 
chandise which will be sold that day. Such a program is 
not feasible for two reasons : 

1. In a mercantile store, it is necessary to have some merchandise 

on hand for display purposes. The customer desires an assort- 
ment from which to select his purchases. This necessitates the 
keeping on hand of a considerable quantity of merchandise. 
The amount which must be kept is dependent on the extent of 
the sizes, varieties, and grades of the merchandise which is 
kept for sale. 

2. It is impossible to estimate sales demands or to plan purchases 

deliveries with sufficient accuracy to have the same amount 
delivered each day as is sold on that day. To provide against 
a failure to meet sales demands it is necessary to keep a cer- 
tain amount of merchandise on hand, which is termed the 
merchandise inventory. 

The principal problem in merchandise planning is to 
determine the size of the inventory which should be main- 
tained, and to set up a purchases program which will schedule 
deliveries to stock in such quantities and at such times as to 
provide for its maintenance at this amount. The problem 
of purchases requirements resolves itself, therefore, into a 
problem of finished stock requirements. 

The problem of setting up an estimate of finished stock 
requirements necessitates : 

1 . An estimate of the sales that will be made of each kind and class 

of goods. This estimate is provided by the sales program. 

2. A statement of the inventory of finished goods that has proved 

sufficient in meeting the sales requirements of preceding periods. 



212 BUDGETARY CONTROL 

This information is used as a basis for the preparation of 
an estimate of the finished goods inventory requirements 
throughout the coming seUing period. 

Method of Determining Inventory 

If inventory figures are to be available for prompt use in 
the preparation of the purchases budget, it is necessary that 
a definite method by which inventory is to be secured be 
determined and the appropriate procedure for the enforce- 
ment of this method be established. 
/ There are three methods in current use by which inven- 

tories may be obtained. These will be discussed under the 
following headings: 

1. Perpetual inventory 

2. Estimated inventory 

3. Physical inventory 

/ Perpetual Inventory 

All the information required in setting up a system of 
finished goods stock requirements is contained in a merchan- 
dise account that shows the quantities of each merchandise 
item received at cost contra to the amounts of the item sold, 
the sales being also computed at cost. The resulting bal- 
ance shows the amount of each item of merchandise on hand 
at cost. Such a merchandise account is commonly known 
as a perpetual inventory. 

If a perpetual inventory is maintained on the goods in 
stock, it will show the cost of such goods as they are shipped 
from the vendor, and will also show the value at cost of 
goods shipped under sales invoices. The net figures in such 
an inventory will indicate at all times the goods on hand. 

It is possible to keep the inventory record in terms of 
quantities rather than in terms of value, if desired. A form 
of inventory record suitable for use in connection with raw 



THE PURCHASES BUDGET 213 

materials is shown in Figure 9 (page 153). The record for 
general merchandise is usually more simple than this form, 
but the same principles govern its construction and use. 

Estimated Inventory 

The experience of merchants is that perpetual inven- 
tories are often expensive in their operation. This is espe- 
cially true where many small items are bought and sold, and 
where the average turnover of the stock is high. Many mer- 
chants content themselves with estimated inventories of 
merchandise on hand, and these estimates are proven as to 
their accuracy by actual inventory once or twice a year. 

The estimated inventory is determined on the basis that 
the actual inventory at the beginning of the period, plus 
purchases for the period, plus the estimated gross profit 
subtracted from the sales at sales price, equals the ending 
inventory. The method of arriving at this formula will be 
seen easily if the organization of the trading section of the 
pro forma statement of profit and loss is considered. 

It may be assumed that the trading section of the state- 
ment of profit and loss of the Brown Mercantile Company 
for the month of December appears as follows : 

The Brown Mercantile Company 

Statement of Profit and Loss 

For Month Ended December 31, 192- 

Sales $51 ,000 . 00 

Inventory, December i . $16,500 .00 

Purchases for month 34,100 . 00 

Total Merchandise in Stockroom during month $50,600.00 

Inventory, December 31 13,200.00 

Cost of Goods Sold 37, 400 • 00 

Gross Profit on Sales $13,600 . 00 



214 BUDGETARY CONTROL 

From the foregoing statement, it is possible to prepare 
the following equation: 

Sales — Beginning Inventory — Purchases + Ending Inventory 

= Gross Profit 

Ordinarily when a statement of profit and loss is made, 
the only unknown quantity is the gross profit, and it is 
obtained by this equation. When it is desired to use this 
formula for estimating the ending inventory, there are two 
unknown quantities — the ending inventory and the gross 
profit. One of these must be determined before the equa- 
tion can be solved. This is accomplished by estimating the 
gross profit. To make the estimate, the ratio of the average 
gross profit to sales during the past periods is determined, 
and this percentage is applied to the sales of the current 
period to obtain the estimated gross profit for this period. 

To illustrate, it is found that the average gross profit of 
the Brown Mercantile Company during the past three 
years has been 26.66 per cent of sales. It is thought that 
the average gross profit of these years is indicative of the 
gross profit of the month of December of the current year. 
By taking this percentage of the sales for this month, the 
estimated gross profit is calculated to be $13,600. By using 
this figure, the equation given above can be stated as follows : 

$51 ,000 — $16,500 — $34, 100 + Ending Inventory = $13,600 

By transposition and solving, the ending inventory is de- 
termined to be $13,200. Since the gross profits on dif- 
ferent lines of goods varies, it is necessary to perform the 
foregoing calculation for each line of goods if an accurate 
estimated inventory is to be obtained. 

It should be evident that estimated inventories can be 
only approximately correct. If the merchandise manager 
has before him only estimated inventories as at the close of 



THE PURCHASES BUDGET 215 

each month or fiscal period, he must use his judgment in 
basing his actions on them. In any case frequent tests 
should be made to verify the accuracy of the estimate. 

Physical Inventories 

In those businesses where it is not feasible to maintain a 
perpetual inventory because of the cost involved, and where 
it is impossible to obtain an accurate estimated inventory 
because of the widely varying rates of gross profit, it may 
be necessary to resort to actual inventories taken at fre- 
quent intervals. This necessitates the taking of a physical 
count of the goods on hand. 

Some department stores take an inventory in certain 
departments every two weeks. Such a check-up at frequent 
intervals is especially desirable in the case of variety goods, 
where fashion and styles play an important part. Practi- 
cally all businesses take a physical inventory yearly, and 
there is a decided tendency towards semiannual and quar- 
terly inventories. It has been found that if a standardized 
procedure for the taking of inventories is properly worked 
out, the task is not so great as it was formerly thought to be. 

Relation of Inventory Planning to Statistics of Past Periods 

In estimating inventory requirements it is necessary to 
refer to the statistics of previous periods as shown by the 
accounting records. As to how many past periods should 
be considered will depend on the circumstances of each case. 
The statistics desired are those which will most nearly indi- 
cate the probable condition of the current year. It may be 
that conditions have changed so rapidly that it is deemed 
wise to use only the statistics available for the preceding 
period, or, on the other hand, the preceding period may be 
considered as abnormal and may be disregarded entirely. 

In some cases a weighted average of three or more past 



2l6 BUDGETARY CONTROL 

periods is taken. In any case, the object is the same — to 
obtain the statistics with reference to past operations which 
will be most helpful in planning future operations. For I 

the sake of brevity in the following discussion, reference will 
be made to the "past period" or ''past periods" without 
defining the length of this period, or periods, unless such 
definition is necessary to make the meaning of the discus- 
sion clear. 

Determination of * 'Normal" Inventory . 

In the preceding discussion it has been explained that 
the next step in merchandise planning after the sales esti- 
mate is prepared , is to determine the ' ' average " or " normal ' ' 
inventory which is necessary to meet sales demands. To 
accomplish this it is necessary: 

1. To determine the average inventory during past periods. 

2. To determine the ratio of the average inventory of past periods 

to the sales of those periods, that is, determine the merchan- 
dise turnover of those periods. 

3. To apply the turnover of past periods to the estimated sales of 

the current period to obtain the average inventory for the 
present period. 

Determination of Inventory of Past Periods 

If any rational control has been exercised over stock 
investments during the past periods, inventory of stock on 
hand must have been taken at frequent intervals. This 
inventory may have been obtained by any of the methods 
discussed in the preceding paragraphs. 

If it was deemed necessary to know the value of the 
stock on hand only at the beginning and the end of the 
period a physical inventory may have been taken. If it was 
deemed desirable to have the value of the stock on hand 
at more frequent intervals, it is probable that either an 
estimated inventory was determined at regular intervals or 



THE PURCHASES BUDGET 21 7 

stock records established which made possible a perpetual 
or continuous inventory. 

It is apparent that the more frequently the inventory 
is determined, the more useful are the statistics obtained 
thereby in determining average inventory and in planning 
stock investment control. In any case the desire for 
accuracy must be balanced against practicability. 

Calculation of Turnover 

Whatever method of taking inventory has been followed 
during the past periods, it should be possible to determine 
at least approximately the average inventory and the ratio 
of the average inventory of each period to the sales for the 
same period. In other words, the turnover for each of the 
past periods can be determined. If the turnover computa- 
tions are to be of value, it is necessary that care be exercised 
to calculate them properly. 

In practice it will be found that several methods are used in the 
determination of merchandise turnover. There are in fact but two 
methods of determining turnover accurately. They are as follows : 
I . Divide the cost of the goods sold during the year by the cost 
of the average inventory of the year. For instance, a retail store 
carries on the average a stock of goods the cost price of which is 
$20,000 and makes during the year sales of $100,000 on which a gross 
profit of twenty per cent is made. The cost of the goods sold is $80,- 
000 and the turnover is four. 

In other words, in this store, on an average, the articles sold re- 
main in stock three months after they are purchased before they are 
sold. It will, of course, be realized that it is rather dangerous to try 
to determine the average turnover on all goods carried in stock. It 
is more accurate to determine if possible the turnover for each kind 
of goods, since the turnover varies on each kind. 

2. The turnover may be determined by dividing the average in- 
ventory for the year at sales price into the sales at sales price. For 
instance, taking the illustration given above, where the average in- 
ventory at cost is $20,000 and the sales for the year are $100,000 on 
which an average gross profit of twenty per cent is made ; if the inven- 



2l8 BUDGETARY CONTROL 

tory is taken at sales price, it will be seen that it will amount to 
$25,000, and dividing the sales of $100,000 by $25,000, a turnover 
of four will be obtained. 

It will be seen that the same result is obtained as in the first case 
where the inventory at cost is divided into the sales at cost. Either 
method can be used, whichever is the more convenient.^ 

The error is sometimes made of dividing the sales at 
selling price by the inventory at cost. This obviously gives 
a turnover larger than the actual one. 

When a firm relies on a physical inventory taken once a 
year, it may determine its average inventory by taking one- 
half of the sum of the beginning and ending inventories. If 
the sales of the business are subject to seasonal fluctuations, 
this method will not give satisfactory results, since it does 
not give effect to the fluctuations in inventory which must 
inevitably result from the fluctuations in sales. The proper 
method is to obtain the average of the monthly inventories. 

Use of Turnover Figures 

Turnover figures are very useful in merchandise control. 
As Nystrom, in his ''Economics of Retailing," very aptly 
says : 

One of the productive factors of a retail store is the capital in- 
vested in its stock of goods. When this capital is borrowed for use in 
the store, interest must be paid for it, and interest should be entered 
as an expense charge in any case regardless of whether the manager of 
the store borrows or supplies capital from his own fun,ds. Efficiency 
in its use depends upon its activity. By activity is meant the num- 
ber of times it can be used over and over again in the course of a 
year. Each complete use of the capital invested in merchandise is 
known as a "turnover." If expenses and profits per sale remain 
the same, the greater the number of turnovers within a year, the 
greater the net profit resulting. This fact has long been recognized. 
There is an old maxim that expresses the idea exactly: "A nimble 
sixpence is better than a slow shilling." 



McKinsey, Bookkeeping and Accounting, Vol. I. 



THE PURCHASES BUDGET 219 

From the viewpoint of our present discussion we 
are interested in turnover primarily as a basis for determin- 
ing inventory requirements. After the turnover of past 
periods is calculated, it is necessary to give it careful consid- 
eration before using it as a basis for merchandise planning. 
Whether or not the turnover of past periods will be used as a 
basis for planning stock control for the current period, will 
depend upon whether the average inventory of the past 
periods is deemed to be satisfactory or not for the purpose. 

It may be that the inventory during the past periods 
was too large and the turnover too slow. Or it may be 
that the inventory was too small for the volume of sales 
which were possible. 

The merchandise manager may know that in the case 
of many articles a much larger inventory was carried than 
was necessary to meet the volume of sales, and he esti- 
mates that a smaller inventory may be carried during the 
coming year and the same volume of sales be obtained. 

On the other hand, he may know of many articles the 
sales of which could have been increased if a larger variety 
or assortment had been carried, or if the goods desired by 
the customer had always been on hand when called for. 
He may rightly decide that the turnover of past periods 
must be modified before it can be used as a basis in deter- 
mining the average inventory to be maintained during the 
current year. 

The foregoing discussion indicates two facts of impor- 
tance in connection with inventory and turnover. First, it 
indicates that it is unsafe to take average turnover, that is, 
the average turnover of all lines carried, especially if goods 
of many different varieties are carried in stock. As pre- 
viously suggested, it is usually necessary to determine the 
turnover of each different class of merchandise carried. 

Secondly, it indicates the need for the intelligent consid- 



220 BUDGETARY CONTROL 

eration of statistics with reference to past operations and 
their modification in the hght of past experience before they 
are used as a basis of future plans. 

Whether the turnover of the past periods is deemed 
satisfactory or is modified as suggested above, a figure is 
finally determined which is used in connection with the esti- 
mated sales of the current period, to arrive at the average 
inventory deemed necessary to meet these sales. The proc- 
ess involved is illustrated by the following steps : 

1. Sales for the past period $500,000 

2. Average inventory for the past period $100,000 

3. Turnover for the past period 5 

4. Estimated sales for the current period $600,000 

5. The estimated average inventory for the current period is $120,000 

It is, of course, assumed in the foregoing illustration and 
discussion that the inventory and sales are both stated at 
the same price, either both at selling price or both at cost 
price. 

The Buying Budget 

When the estimated inventory has been determined, it 
is then necessary to make a schedule of deliveries and pur- 
chases which will maintain this inventory. If the sales of 
the period fluctuate to any great extent, it will probably be 
necessary to determine the inventory desired at the begin- 
ning of each month. Then, to determine the deliveries to 
stock which must be made during the month, it will be 
necessary to add the estimated sales at cost for the month 
to the estimated inventory at the end of the month, and 
subtract the inventory at the beginning of the month. 

It can be seen from the foregoing that the normal inven- 
tory, that is, the inventory which it is estimated will have 
to be carried to meet the sales demands, may not be an 
average or uniform inventory, but may fluctuate from 



THE PURCHASES BUDGET 



221 



month to month as the sales fluctuate owing to seasonal 
demands, etc. It should also be realized that in many cases 
it may be desirable to make the finished goods schedule in 
terms of the number of items required rather than in terms 
of value. 

To illustrate the preparation of a schedule of deliveries of 
finished goods, it may be assumed that the New York De- 
partment Store, which makes a specialty of high-grade 





NEW YORK DEPARTMENT 


STORE 








Furniture Department 








X-Y PIANO 






Month 


Stock 
Beginnings 


Sales 


Stock 
End 


Deliveries 
to Stock 


Memorandum 


Nov. 


16 


3J^ 


U 


32 


Xmas season 
begins Nov. 15 


Dec. 


U 


21 


10 


1? 


Xmas season 
ends Dec. 18 


Jan. 


10 


17 


15 


22 


Jan. Bargain 
sales begin 
Jan, 1920 


Feb. 


15 


32 


s 


25 


Bargain sale 
ends Feb. 20 



Figure i8. Schedule of Deliveries to Stock 

pianos in its furniture department, desires to set up a sched- 
ule of deliveries to stock of a certain grade of piano during 
the months of November, December, January, and Feb- 
ruary. Such a schedule may be in the form shown in 
Figure i8. 

A similar schedule of finished goods deliveries will need 
to be prepared for each item of finished stock. If the sched- 



J 



222 BUDGETARY CONTROL 

ule is made in terms of value, the only difference will be the 
method of stating the quantity in each column. 

Responsibility for Preparation of Estimate of Purchases 

As to the unit of the organization which should be held 
responsible for the preparation of the estimate of pur- 
chases, no arbitrary rule can be established. The nature, 
size, and organization of the business must be considered in 
each case. In so far as possible the purchases estimate, 
like all other estimates, should be made by those who are 
responsible for its enforcement. 

In a business with branches which handle resale ma- 
terial, the branch manager may make the purchases which 
his branch needs, under the supervision and functional con- 
trol of the general purchasing agent of the company. In 
this case each branch manager should be held responsible for 
making an estimate of the purchases of his branch. These 
original estimates of the branch managers will be gone over 
by the general purchasing agent, who will transmit them 
with his approval to the executive in charge of the budgetary 
procedure, who in turn will transfer them to the budget 
committee for consideration and approval. 

Although revisions may have to be made in the estimates 
submitted by the branch managers, it is desirable that they 
prepare these for two reasons: 

1. They will take more interest in their execution if they are re- 

sponsible for their preparation. If they receive an estimate 
prepared by someone else, they may not feel the proper amount 
of responsibility for any variations between the actual and 
the estimated figures. 

2. In the making of their estimates the branch managers must 

study past operations and plan future ones. This study 
and planning will be of much value to them; it will bring 
to their attention many things which they would otherwise 
not notice. 



THE PURCHASES BUDGET 223 

In a department store the head of each department is 
responsible for the preparation of the estimate of purchases 
for his department. In preparing this, he may employ the 
assistance of the various buyers in his department. After 
being prepared, these departmental estimates will be ex- 
amined by the merchandise manager, who will make such 
revisions as he deems necessary. 

In a business where all purchases are made by a central 
purchasing department under the control of a general pur- 
chasing agent, the estimate of purchases may be prepared 
under his direction, but he will usually obtain the assistance 
and advice of subordinates in its preparation, and his esti- 
mate will be based on the estimated requirements submitted 
by the various departments. 

Whatever is the origin of the original estimate, it will be 
transferred to the executive in charge of the budgetary pro- 
cedure, and by him submitted to the budget committee for 
consideration and approval. 

Purchases Budget Control 

The purchases budget provides a working program for 
the current period. But this program is based on estimates 
which, however carefully made, may prove inaccurate be- 
cause of market conditions that could not be foreseen at 
the time these estimates were made. If the estimates 
prove incorrect, it is necessary to change as soon as possible 
the plans which were based on them. If it is estimated that 
the sales for the current year will be 25 per cent more than 
they were for the past year, a purchases budget will provide 
for a corresponding increase in purchases. But if at the 
end of the first month the sales have not increased and mar- 
ket conditions indicate that the anticipated increases will 
not materialize, it would be very unwise to continue to fol- 
low the original purchases budget. It is necessary, there- 



224 BUDGETARY CONTROL 

fore, to have certain records and reports to make possible a 
revision of the purchases budget throughout the year, if the 
results^ during the year make such a revision necessary. 

A revision of purchase quotas to meet changing trade 
conditions is not a simple task in the case of a department 
store where quotas are made out months in advance on 
thousands of different items. Perhaps the simplest way to 
make changes on numerous quotas is to compute the per- 
centage that the delivery quota for the month is to the esti- 
mated sales for the month. Thus, if the estimated sales are 
43 units and the delivery quota is 38 units, we may express 
the quota as 88.3, so that if the actual sales are 51 units we 
may permit, without being criticized, the delivery into stock 
of 88.3 per cent of 51 units, or 45 units. For reasons that 
are obvious, this percentage method does not give us a quota 
that will result in the exact inventory at the end of the 
month for which we originally planned. But this use of per- 
centages is decidedly useful for revising large numbers of 
quotas to meet discrepancies between estimated and actual 
sales. 

There should be prepared monthly for the use of the 
executives responsible for the purchasing program and for 
the budget committee, a report similar in form to Figure 19. 

Interpretation of Illustration 

The amounts given for each item or line of goods in the 
first money column will be taken from the last revision of 
the sales program. In columns (4) and (5) a comparison is 
given between the delivery to stock quota on each item and 
the estimated sales at cost for the item. It must be remem- 
bered that estimated sales are taken at cost so that there 
may be this comparison between sales at cost and purchase 
quotas at cost. In column (6) a percentage of the quota to 
sales at cost is shown for each item. The data for column 



THE PURCHASES BUDGET 



225 



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226 BUDGETARY CONTROL 

(6) is not taken from the accounts, but is the result of divid- 
ing estimated sales at cost into quotas. The actual sales for 
the month shown in column (7) will be taken from the sales 
as reported in the sales accounts of the month. From the 
sales, as reported in the sales accounts, estimated gross 
profit is subtracted. When actual inventory has been 
taken at the end of the month, actual gross profits, as shown 
by the accounts, should be subtracted. The revised quotas 
given in column (8) may be made by applying the quota 
percentage given in column (6) to actual sales at cost as 
given in column (7) . The amounts of deliveries into finished 
stock, as shown in column (9), will be taken from the pur- 
chase accounts. The orders outstanding as shown in col- 
umn (11) will be taken from an order register if a book 
record of orders is maintained, or they may be found by 
adding the unfilled orders on file. 

If a monthly quota system is maintained on stock de- 
liveries, the unfilled orders at the end of a month furnish 
useful information to use as a basis for purchase control. 
It may be that unfilled orders represent poor buying, or it 
may be that they represent a lack of coordination of the 
activities between the purchase and other departments of 
the business. In any case, the reason for such unfilled 
orders should be determined and such executive action 
taken as is necessary to remedy the condition. 

Use of Control Reports 

Control reports are a necessity to the head buyer of a 
store if the activities of the various assistant buyers are to 
be coordinated so that they may all work towards a common 
end. He makes use of purchase quotas and the subsequent 
reports on these quotas for the unification of the plans of 
his buying organization. The quota set up on article S485, 
a shoe, is coordinated with the quotas set up on article H563, 



THE PURCHASES BUDGET 227 

a silk stocking, because both the shoe and silk stocking are of 
a certain color, shade, and quality, and are expected to 
be sold together in many cases. In like manner, there 
will be planning on quotas of staple articles with reference 
to certain proposed bargain sales, and also on quotas of 
certain specialties with reference to their use as liners. In 
the same manner, quotas on various lines and variety of 
goods are considered in connection with each other to the 
end that a well-coordinated sales and purchase program may 
be formulated. And then reports are made on these quotas 
which serve as a means of correcting errors of judgment on 
the original quotas and of detecting failures to execute prop- 
erly the program based on these quotas. 



CHAPTER XV 
THE PURCHASES BUDGET (Continued) 

Disbursements for Purchases 

The discussion in the preceding chapter has dealt 
primarily with the method of securing a coordination be- 
tween purchases and sales. This is essential, but in addi- 
tion it is necessary to provide for the coordination of 
purchases with finances. To do this it is necessary to 
determine the monthly expenditures in payment of pur- 
chases. 

The finished goods budget shows the deliveries to stock. 
From the viewpoint of financial requirements, it is necessary 
to determine when the goods delivered are to be paid for. 
The method of doing this will depend on the volume of 
purchases to be made, and the terms on which they are to 
be purchased. It may be necessary to classify all purchases 
made by credit terms so as to obtain the data by means of 
which an estimate can be made as to the amount of the 
estimated purchases which will be made on such terms. 
It will then be possible to estimate the disbursements which 
will be made for the purchases made on each kind of terms. 

To illustrate, if it is found that 50 per cent of the pur- 
chases during the past three years have been on terms 2/10, 
n/30, and that the payment is always made within the 
discount period, it may be estimated that 50 per cent of 
estimated purchases for the next period will be paid within 
ten days after the receipt of the invoice. On this basis it 
may be estimated that two-thirds of the merchandise pur- 
chased on these terms which is to be delivered during the 
next month, will be paid during that month, and that in 

228 



THE PURCHASES BUDGET 229 

addition it will be necessary to pay during the month for 
one-third of the merchandise purchased on these terms 
during the preceding raonth. 

In the same manner, estimates can be made for dis- 
bursements to be made in payment for merchandise pur- 
chased on each class of terms. The errors which may arise 
in making such estimates are apparent. There are a num- 
ber of factors which influence their exactness. It is well 
to remember, however, that cash receipts and disbursements 
can never be estimated with absolute exactness. The cash 
balance is maintained to provide for this inaccuracy in the 
same way as the inventory of finished goods is carried to 
provide for the inaccuracy of the sales and purchases esti- 
mates. Further discussion of the method of estimating 
disbursements will be found in Chapter XIX in connection 
with the treatment of the financial budget. 

Report on Disbursements for Purchases 

As a means of controlling the disbursements for pur- 
chases and of providing data for the financial budget, it is 
well to have an estimate made as shown in Figure 20. 

The form as given is premised on a budget period of 
three months in length. It can of course be adapted for 
use for a budget period of any length, but the longer the 
period, the more inaccurate the estimates for the latter 
part of the period are apt to be. In any case, it should be 
revised monthly on the basis of the monthly reports, show- 
ing actual sales, actual purchases, and actual disbursements. 

Use of Estimate of Disbursements for Purchases 

The report shown in Figure 20 provides information 
which is of value not only in judging the advisability of the 
contemplated purchasing program, but also the advisability 
of the contemplated sales and financial programs. The 



230 BUDGETARY CONTROL 

most important items of information which it shows are 
the following : 

1. The estimated deliveries to stock during the month. This can 

be checked against the same item on the schedule of deliveries 
to finished goods to determine the accuracy of the amount. 

2. The estimated orders to be placed during the month. This 

provides a check on the amount of orders which are to be 
placed for future delivery. This enables the executives to 
know the plans of the merchandise or purchasing department 
so that they can curtail these plans if they deem this necessary. 
It indicates to the treasurer the possible demand for funds for 
the payment of vendors' claims. 

3. It shows the estimated inventory at the end of the period. By 

comparing this with the inventory at the beginning of the 
period, it can be seen whether the purchasing program con- 
templates an increase in inventory. If so, the reason for this 
increase can be ascertained. It may of course be desirable for 
the inventory to be increased for several reasons which are no 
doubt apparent to the reader, but it is well for the contemplated 
increase to be called to the attention of the principal executives 
for their approval. 

4. It shows the disbursements to be made during the month for 

purchases made during previous months. These are disburse- 
ments which presumably must be met, since the contracts are 
already made. This is useful information for the treasurer. 

5. It shows the estimated disbursements for purchases made during 

the month. This amount is of course subject to change in 
case the estimated purchases are changed. 

The estimate of purchase disbursements as a whole 
provides information which is useful in estimating the 
financial requirements of the contemplated sales program. 
If such requirements are too great, a revision of the sales 
program may be necessary. 

Classification of Purchase Data for Control Purposes 

The discussion in the preceding chapter has pointed out 
the necessity for records and accounts for purchases, and 



THE PURCHASES BUDGET 



231 



CO 

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CO 

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CL 

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a: 
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z: 


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Estimated 
Cash Dis- 
bursements 
lor Pur- 
chases 
made 
during the 
Month 






,— ■ ^. 




Inventory 

at 
Beginning 

of 
Month 






3: 
1— 



Q 
2: 


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Estimated 
Cash Dis- 
, bursements 
for Pur- 
chases 
made 
during the 
Month 






Estimated 
Cash Dis- 
bursements 
for Pur- 
chases 
made 
during Pre- 
vious 
Month 






Estimated 

Inventory 

at 

End 

of 

Month 






Estimated 
Orders 
to be 
placed 
during 
Month 


1 


Estimated 

Deliveries 

to 

Stock 

during 

Month 






Inventory 

at 
Beginning 

of 
Month 






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Cash Dis- 
bursements 
I'or Pur- 
chases 
made 
during the 
Month 


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Estimated 
Cash Dis- 
bursements 
for Pur- 
chases 
made 
during Pre- 
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Munth 






Estimated 

Inventory 

at 

End 

of 

Month 






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to be 
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during 
Month 






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during 

Month 






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232 BUDGETARY CONTROL 

the need for records and files for unfilled orders if Informa- 
tion is to be available for the preparation and control of 
the purchase program. But this information must not 
only be available, it must be available in such form as to 
make this control comprehensive and not unduly burden- 
some. For that, it is necessary that a proper classification 
of purchase accounts and purchase orders be maintained. 
The classification which is necessary for the preparation of 
the monthly report shown in Figure 19 (page 225) is indi- 
cated by the report itself. 

For the purpose of this report the purchase accounts 
must analyze the purchases into the same classes by which 
they are shown on the purchases budget, and outstanding 
orders must be classified in the same manner. For in- 
stance, if the purchases budget states a separate quota for 
twenty different types of purchases, there must be twenty 
different accounts maintained with purchases, or some 
supplementary record must be kept which provides for 
such a classification if the monthly report shown in Figure 
19 is to be used effectively. The outstanding orders must 
also be subject to such a classification if the desired in- 
formation for column (10) is to be obtained. But if this 
report is to be properly interpreted after it is made, ad- 
ditional information with reference to purchases raade and 
orders issued is necessary, and to obtain this information 
other classifications must be maintained. 

Classification of Purchase Invoices 

Purchases, in addition to being classified to correspond 
to the analysis shown on the purchases budget, may be 
analyzed as follows: 

1 . By departments or units of responsibility 

2. By terms of credit 

3. By buyers 



% 



THE PURCHASES BUDGET 233 

In a business where there is any attempt toward func- 
tional organization and control, both sales and purchases 
are usually classified according to the units of organization 
for responsibility. Expenses are classified similarly, and 
consequently the efficiency of the functional managers can 
be judged in terms of profit and loss. For instance, in a 
department store the departmental managers are held 
responsible for the operations of their departments, and 
consequently the sales and purchases are analyzed by de- 
partments so that departmental profit and loss can be 
determined. In such a business the sales estimates and 
purchasing estimates are usually made separately for each 
department, so that the departmental analyses serve a 
double purpose in that they serve not only as a check upon 
the efftciency of departmental heads, but also as a basis for 
the preparation and control of the departmental estimates. 
In a business with branches, the responsibility for the 
management of each branch is imposed on the branch 
manager, and in order to determine his efficiency an 
analysis of purchases, sales, and expenses by branches 
is necessary. 

In planning the financing of a firm's operations, it is of 
considerable value to the financial executive to know the 
terms on which the estimated purchases will be made. It 
has been explained above that the terms of purchase must 
be taken into consideration in the preparation of the esti- 
mate of purchases. If that is done, the purchase invoices 
may be analyzed by terms of credit so that statistics will 
be available to show the purchases made on each kind of 
terms. This analysis can then be used in estimating the 
proportion of the total estimated purchases which will be 
made on each kind of terms during the budget period. 
Often this classification is not shown on the ledger accounts, 
but only in a supplementary record. In a large business 



234 BUDGETARY CONTROL 

where several analyses are to be made, it will probably be 
obtained by a tabulating equipment. 

Sometimes it is desirable to know the quantity of pur- 
chases made by different buyers, and the purchase invoices 
are analyzed accordingly. Such an analysis may be of 
value in assigning quotas to buyers and keeping a check on 
the amount purchased by different buyers or judging as to 
the wisdom of continuing the services of particular buyers. 

There may be various other classifications of purchases 
under different circumstances, such as commodity classifi- 
cation, classification by vendors, etc. The classification 
shown on the purchase budget is usually by commodities 
or by groups of commodities. 

Classification of Unfilled Orders 

The unfilled purchase orders, in addition to being classi- 
fied according to the analysis shown on the purchases 
budget, should be classified so as to show the following: 

1 . Month of delivery 

2. Contract orders 

3. Orders subject to cancellation 

It should be apparent that it is quite important to know 
the month of delivery of the goods for which orders are 
outstanding. Without this information, it is impossible 
to determine the proper delivery dates of goods still to be 
ordered. If orders are outstanding for goods to be delivered 
six months hence, this can have no effect on purchases 
necessary to satisfy the needs of the current month. The 
time of delivery is also of value to the financial executive in 
arranging for the payment of the goods delivered, and to 
the operating superintendent in planning to store and 
handle them. 

It is also important in planning future deliveries to 



THE PURCHASES BUDGET 235 

know the amount of contract orders, the period covered 
thereby, and the extent to which deliveries under such 
contracts are subject to shifting. It may be desirable to 
speed up deliveries or to delay them, depending on the ex- 
tent to which the sales program may exceed or fail to reach 
the estimated program. 

The amount of those orders that are subject to cancella- 
tion is also quite important, especially if it becomes neces- 
sary to reduce the buying quota because of a failure of the 
sales program to attain the estimated goal. 

In order that the amount of each class of purchase 
orders mentioned may be readily available, supplementary 
records may be kept which classify the orders as issued and 
show them as filled when goods are received. But if these 
records are to be of the greatest service, they must be 
accurate, and to this end periodical audits should be made 
to test their accuracy. Oftentimes, because these records 
are not a part of the general financial records, proper care 
is not given to their operation and verification. 

Relation of Purchasing Budget to Merchandise Policies 

The discussion in the preceding chapter has explained 
the method of determining the "normal " inventory and the 
formulation of a purchasing program based on this inven- 
tory. A brief consideration of the method employed in 
determining the normal inventory will show that it rep- 
resents what would be a satisfactory inventory under the 
conditions of the preceding period. It should be apparent 
to the reader that it is not always safe to assume that these 
same conditions will continue during the current period. 
Consequently the estimated average inventory, as deter- 
mined by the method shown in the preceding chapter, may 
be modified by a consideration of the anticipated market 
conditions of the current period. 



236 BUDGETARY CONTROL 

There are many considerations which may make such 
modifications desirable. It may be thought desirable to 
purchase a large amount of stock early in the period because 
of an anticipated increase in price, or because it is anticipated 
that there may be congested trafhc later, or because of other 
conditions. On the other hand, it may be thought desir- 
able to let the reserve stock fall below normal because of 
an anticipated fall in the market price. The merits of this 
procedure have been considered in Chapter X, in discuss- 
ing the raw materials budget. 

In some cases, changes in personnel of customers may 
be expected to increase turnover, making a smaller inven- 
tory possible. For instance, a large inflow of war workers 
during the war period increased the sale of certain grades 
of goods in some cases, and made a more rapid turnover 
possible. On the other hand, an attempt to cater to a more 
fastidious trade may tend to necessitate a large inventory 
in order to provide the proper variety. 

The foregoing are but a few of the many changes in 
market conditions which may affect the purchasing pro- 
gram. Comparisons of statistics of past years by lines of 
goods, territories, and personnel of trade will help in de- 
termining the modifications necessary to arrive at the 
proper estimated inventory for the current period. 

Use of Purchases Budget to Control Conditions of Stock 

The purchases budget may be used in many ways to 
assist in the control of various conditions of stock. If the 
warehousing facilities are limited, the purchases budget, by 
providing for a more or less uniform inventory, and conse- 
quently uniform deliveries into stock, will prevent the 
arrival of stock to an amount greater than can be properly 
stored. It can be seen readily that if there is not coopera- 
tion between the purchasing department and the operating 



THE PURCHASES BUDGET 237 

or warehouse department, very undesirable situations may 
arise. 

Again, if the purchases budget is properly made and is 
faithfully followed, it will be possible to have a well-formu- 
lated system of reserve and forward stocks, and there will 
be little danger of the reserve stocks being exhausted when 
it is necessary to replenish the forward stock. In some lines 
of business, such as mail-order houses and wholesalers of 
standard lines of clothing, this is a matter of prime im- 
portance. 

A properly controlled buying budget will eliminate the 
necessity of making omissions or substitutions in filling 
orders. The demands of the orders are anticipated in the 
sales estimate and the correlated buying budget, and the 
goods are on hand when the orders arrive. Such a budget 
will also eliminate the need for holding unfilled sales orders 
until goods are purchased with which to fill them. 

In short, the purchases budget, like the sales budget, is 
one of the connecting links between the various departments 
and serves as a basis for coordination of all the activities of 
the business. 

Relation of Purchasing Program to Merchandise Policies 

The purchasing program is but one part of the merchan- 
dise program and in the formulation of the latter a number 
of factors must be considered. Some of these factors are 
external to the business organization, while others are mat- 
ters of internal policy. Illustrations of the former were 
given in the discussion of the relation of market conditions 
to the purchases budget. Some of the most important 
internal factors which must be given consideration in 
merchandise planning are: 

1. Sales 3. Turnover 5. Mark-downs 

2. Inventory 4. Purchases 6. Expense 



238 BUDGETARY CONTROL 

Each of these factors must be given careful consideration in 
making the merchandise plans of each department, and 
the policy of the firm with reference to each given proper 
emphasis. 

It may be said, by way of caution, that "external" and 
"internal" factors which affect the merchandise plans are 
closely related. Each may have an effect on the other. 
For instance, the market conditions may be such that the 
company may find it necessary to alter its usual policy with 
reference to inventory, purchases, or expense. 

Importance of a Consideration of Expense 

In the preceding discussion it has been assumed that all 
the plans of the business are based on the sales program. 
It has been explained, however, that the sales program is 
based not alone upon sales possibilities, but also upon 
production or purchasing capacity, expense requirements, 
and profit potentialities. As the expense factor is an im- 
portant one in a mercantile business, it seems worth while 
to emphasize again the importance of giving it very careful 
consideration in forming the sales program and the relative 
purchasing program. 

It is important to see the anticipated expenses of each 
department and to determine if the sales program is suffi- 
cient to warrant the expenses planned. If that program is 
not sufficient, it is necessary to plan either for an increase 
in sales or for a decrease in expense. It is beneficial to the 
department head to have the relationship between his sales 
and expenses brought forcibly to his attention. After the 
estimated expenses of the department are determined, it is 
well to show the amount of sales which are necessary to 
make possible the incurrence of these expenses with a 
satisfactory margin of profit. 

To make this calculation it is necessary to consider (i) 



THE PURCHASES BUDGET 



239 















DEi 
Re 


'T '1 


PRELIMINARY SIX MON' 

Period from J*"- !• 1922 to 
Retail Stock 
On Hand at 

Bfioinnino of Period 


FHS' PLANS 

July 1. 1922 

Maximum Stocl 
Minimum Stock 
Mark-Downs Al 


tail 


Desired at 
End of Period 






lowed 


Initial Mark-Up Required 




MONTH 


Jan. 


Feb. 


Mar 


April 


May 


June 


TOTAL 


-^M^ 


Ann 


<nnnf 


Or f 


Nnv 






oepl. 








SALES; - 

Last Year 
Estimated 
Result 
















Inventory 
Last Year 
Estimated 
Result 
















TURNOVER: 

Last Year 
Estimated 
Result 
















PURCHASES: 

Last Year 
Estimated 
Result 


- 














Mark- DOWNS: 
Last Year 
Estimated 
Result 
















EXPENSE: 

Last Year 
% 
Estimated 

% 
Result 
% 
















REMARKS 



Figure 21. Showing Merchandise Plan of Each Department of a 

Department Store 



240 BUDGETARY CONTROL 

the estimated sales, (2) the average mark-up, (3) the aver- 
age mark-down, and (4) the expected profit. If we assume 
that the estimated expenses of Department A are $7,000, 
the average mark-up 40 per cent, the average mark-down 
2 per cent, and the expected profit 3 per cent, then the 
necessary sales will be obtained by the following calculation : 

$7,000^[40%-(2% + 3%)] =$20,000 

If the sales program of Department A calls for sales of 
less than $20,000, it must be revised or else the expense or 
profit estimate must be revised. 

If a merchandise plan is made based on a close correla- 
tion between the sales, purchasing, and expense program, 
there will be less likelihood of disappointments at the end 
of the period. 

Report on Merchandise Plan 

The merchandise plan of each department of a depart- 
ment store or wholesale house can be very effectively pre- 
sented for executive consideration by the use of a report 
made in the form shown in Figure 21. 

The information shown on this report is self-explanatory. 
It serves not only as a basis for formulating plans, but can 
also be used as a means of checking their performance since 
it provides for a comparison of the estimated and the 
actual. If desired, sufficient space may be left in con- 
nection with each section so that at the end of each 
month revisions may be shown for each of the following 
months. 

It will of course be understood that this general report 
will be supplemented by a number of detailed reports 
which will serve to explain the summary figures shown on 
it. If desired, this report may be so designed as to show 
comparisons by percentages. 



THE PURCHASES BUDGET 24I 

Review and Summary 

In Chapters V and VI the formation and execution of 
the sales budget has been discussed. In Chapters XIV and 
XV an attempt has been made to outHne the procedure 
involved in the correlation of purchases with sales, and in 
the preparation and execution of the purchases budget. 

In summary form this procedure may be stated as 
follows : 

I. Preparation of Purchases Budget 

First. An estimate of sales is made for the period. To recapitulate 
what has been said in a preceding chapter, this requires: 

1 . An analysis of the sales of preceding periods. The sales accounts 

should furnish this analysis. But several analyses may be of 
value in arriving at the final sales program, and it may be 
necessary to refer back to sales tickets or other vouchers for 
data in making this analysis. Thus if the sales accounts lead 
to a report of sales by lines of goods, it may be of value to refer 
to analyses of sales by terms, by territories, etc. 

2. Use of sales analysis comparisons in estimating sales under existing 

or future trade conditions. 

3. Revision of original sales estimates in the light of purchasing 

possibilities, expense requirements, and profit potentialities. 

4. Comparison of estimates of sales with actual sales accounts dur- 

ing the period, and correction of first estimate as actual sales 
accounts show errors of judgment in setting up the sales pro- 
gram. 

Second. An estimate of turnover for the period is made. To do this 
requires : 

1. Use of inventory accounts and sales accounts of past periods in 

arriving at average turnover for each line of goods in com- 
parable past periods. 

2. Use of past average turnover in estimating probable turnover 

under the existing or future trade conditions. 

Third. Estimated average inventory for the coming period is computed 
for each item or line of finished stock to be sold in the period. For control 
purposes, these estimates are set up in schedules of finished stock inventory 

16 



24^ BUDGETARY CONTROL 

requirements. As the period advances, comparisons are made between 
schedules and the amounts shown by the inventory accounts, and the 
schedules are corrected where errors of judgment are apparent through 
such comparisons. 

Fourth. A schedule of deliveries of finished stock is made. To be 
effective as a basis for management control, this schedule or estimate of 
deliveries should specify the amount of each line of goods that is to be 
placed in stock each week or each month of the period. If the period 
covers six months commencing on January i, the delivery quotas may be 
computed as follows : 

Estimated sales for the month of January at cost. 

Plus inventory expected on January 31. 

Less actual inventory on December 31. 

Equals delivery into stock quota for the month of January. 

Then for the month of February. 

Estimated cost of sales for February. 

Plus inventory expected on February 28. ' 

Less estimated inventory on January 31. 

Equals delivery into stock quota for month of February. 

And so on for each of the six months. If the volume of sales is large and 
fairly constant, as in a mail-order furniture line, such a monthly quota will 
furnish reasonably close limits on purchases. But if the volume of the 
sales in the line is subject to great seasonal variations, as in a department 
store wall-paper line, a weekly quota should be set up for deliveries into 
stock during rush seasons. 

Fifth. An estimate of purchases which will satisfy the schedule of 
finished goods deliveries is set up. This will show estimated orders to be 
placed each month, estimated deliveries to be made, and estimated dis- 
bursements to be made in settlement of vendors' claims. 

Sixth. The schedule of finished goods deliveries and the estimate of 
purchases is approved by the controlling executive authority with whom 
final approval rests. 

II. Reports Used in Preparation and Execution of Purchases 
Budget 

If it is assumed that the buying budget for 1922 is under consideration, 
the name of each report with the money column headings of each which 
would be used in its preparation and execution may be as follows: 



THE PURCHASES BUDGET 243 

First. Weighted Average of Sales for three years for each class of 
goods : 

1. Sales for the year 191 9. 

2. Sales for the year 1920. 

3. Sales for the year 192 1. 

4. Arithmetical average. 

5. Weighted average — to be used as a basis for the sales estimate. 

Second. Sales program for the year 1922 for each item sold: 

1. Weighted average for the three years preceding. 

2. Per cent of 1922 estimated increases and decreases. 

3. Sales estimate for 1922 on each item. 

Third. Monthly Report of Actual Sales under sales program : 

1 . Sales estimated for period to date. 

2. Actual sales for period to date. 

3. Per cent of increase or decrease of actual over estimated. 

4. Add or deduct from sales program for the rest of the period. 

Fourth. Estimated Average Inventory by Classes or Goods and Items: 

1. Actual sales for 1919, 1920, 1921. 

2. Less actual gross profit for 1919, 1920, 1921. 

3. 1 91 9-1 920-1 92 1 sales at cost. 

4. Rate of turnover on each item for 1919, 1920, 1921. 

5. Estimated sales for 1922. 

6." Estimated gross profit for 1922. 

7. Estimated sales at cost for 1922. 

8. Estimated turnover rate for 1922. 

9. Estimated average inventory for 1922. 

Fifth. Estimate of Finished Goods: 

1. Month. 

2. Estimated inventory at beginning of the month. 

3. Estimated sales at cost. 

4. Estimated inventory at the end of the month. 

5. Estimated deliveries to stock during the month. 

6. Comments. 

Sixth. Estimate of Purchases: 

1. Item. 

2. First month: 

(a) Estimated inventory at beginning of month. 

(b) Estimated deliveries to stock during the month. 



244 BUDGETARY CONTROL 

(c) Estimated orders to be placed during the month. 

(d) Estimated inventory at the end of the month. 

(e) Estimated cash disbursements for purchases made during 

previous months. 

(f) Estimated cash disbursements for purchases made during 

the current month. 
3. Second month: 

The same as for first month, and so continued for each month. 

Seventh. Monthly Inventory Comparison Report: 

1. Estimated sales. 

2. Actual sales. 

3. Per cent of increase or decrease. 

4. Estimated average inventory. 

5. Actual inventory. 

6. Per cent of increase or decrease. 

Eighth. Monthly Report on Quotas: 

1. Estimated sales for month. 

2. Estimated gross profit. 

3. Estimated sales at cost. 

4. Purchase quota. 

5. Ratio of (4) to (3). 

6. Actual sales for month. 

7. Revised quota, per cent shown in (5) taken of actual sales shown 

in (6). 

8. Delivered into stock during the month — taken from the purchase 

accounts. 

9. Balance of quota not delivered or excess of quota delivered. 

10. Purchase orders outstanding under quota, not delivered. 

11. Balance in quota not ordered or excess ordered over quota. 

Ninth. Report on Merchandise Plans of Each Department: 
This report may be made in the form in Figure 2 1 . 



CHAPTER XVI 
THE PLANT AND EQUIPMENT BUDGET 

Need for Consideration 

In every business there is need for certain equipment to 
be used in carrying on its operations. The amount and 
nature of this equipment depends on the size and the nature 
of those operations. The professional firm needs little 
equipment and very rarely owns the building in which it is 
housed. The mercantile firm uses a limited amount of 
equipment, depending on its size, and in many cases does 
not own the building in which it operates. The manufac- 
turing firm usually employs a large amount of equipment, 
and in most cases owns the plant in which it carries on its 
manufacturing operations. Consequently a large part of 
the capital of most manufacturing firms is invested in their 
plant and equipment. 

It can be seen, therefore, that expenditures for plant 
and equipment are most important in connection with an 
industrial concern, but that they are of some significance in 
the case of all businesses. The following discussion will be 
devoted primarily to a consideration of the control of expend- 
itures for the plant and equipment of a manufacturing 
business, but the same principles will apply to the control of 
expenditures for plant and equipment of any other type of 
business. 

Classification of Plant and Equipment Expenditures 

The expenditures made in connection with the plant and 
equipment of a business may be classified into the following 
general groups: 

245 



246 BUDGETARY CONTROL 

1. Expenditures which are necessary to maintain the present plant 

and equipment at its normal efficiency. No matter how care- 
fully equipment is selected or how carefully it is used, certain 
expenditures must be made from time to time to keep it in such 
condition that it can be operated efficiently. Such expendi- 
tures are called "repairs." 

2. Expenditures which are made to replace with new equipment, 

old equipment that is worn out and discarded. Regardless 
of the amount spent in the way of repairs, equipment will 
in time be in such a condition that it can no longer be 
operated profitably. It is necessary to purchase new equip- 
ment to take its place. Such expenditures are termed 
replacements. 

3. Expenditures in connection with present equipment which add 

to its life or efficiency. For instance, a machine may be entire- 
ly overhauled; old and worn parts are replaced by new ones, 
with the result that it will continue in use longer than was 
originally estimated. Or a new patent may be added to the 
machine which will not prolong its life but will increase its 
efficiency during its life. Such expenditures are termed 
"betterments." 

4. Expenditures which are made to obtain new equipment which 

does not replace other equipment but which represents an addi- 
tion to the sum total of the equipment employed by the busi- 
ness. As a business expands, it is necessary to secure addition- 
al equipment to carry on the increased volume of business. 
Expenditures for this purpose are termed "additions." 

Treatment of Different Classes of Expenditures 

From the viewpoint of both accounting and financial 
management, the classes of expenditures explained in the 
foregoing discussion are distinctly different and must be 
recorded carefully to show properly their effect on the finan- 
cial condition and operating efficiency of the business. A 
proper record is necessary also for use as a basis in planning 
and executing an effective control of these expenditures. 
It will be necessary to discuss separately the method of 
recording and reporting each class. 



THE PLANT AND EQUIPMENT BUDGET 247 

Repairs 

Repairs are usually considered as a current expense 
of the business, which must be provided for out of the 
income of the fiscal period in which they occur. This 
is on the theory that repairs are necessitated because 
of the operations of the period when they ■ occur and 
that consequently their cost should be borne by that 
period. 

In opposition to this theory it is sometimes urged that 
repairs are not the result necessarily of the operations of the 
period when they occur, but may be necessitated because, 
in part at least, of the operations of previous periods. In 
other words, the operations of one period may cause a ma- 
chine to be so worn that it is almost ready to break down 
at the end of the period, but the break with the consequent 
repair may not actually occur until the beginning of the 
next period. The customary practice assumes, however, 
that repairs ^'even up" from period to period, since each 
period suffers repairs caused in part by the operations of 
previous periods, and in turn transfers ''potential repairs" 
to the next period. Consequently, it is argued that the 
cost of repairs tends to be approximately uniform from 
period to period. 

If, for any reason, M:he cost of repairs fluctuates to any 
extent from period to period, and it is desired to distribute 
their cost evenly, this may be accomplished by estimating 
the average cost of repairs on the basis of past experience 
and future plans, and setting up a reserve for repairs. 
Under this method there will be charged to expense and 
credited to a reserve for repairs an amount equal to the 
estimated cost of repairs. As the repairs take place they 
are charged to the reserve for repairs. 

If standard rates for repairs are established, the prepa- 
ration of the manufacturing expense budget is facilitated. 



248 BUDGETARY CONTROL 

This procedure also assists in the estabhshment of standard 
expense rates such as were discussed in Chapter XIII. 

Replacements 

The cost of replacements is not an expense of the period 
when the replacement takes place, but is an expense of all 
the periods during which the equipment which is replaced 
has been used. If a machine costing $1 ,000 is purchased in 
1 92 1, the year 1921 should not bear the entire cost of the 
new machine, neither should it bear the difference between 
the cost and the scrap value of the old machine. Each of 
the six years during which the machine has been used has 
received a benefit from its use, and consequently, each of 
the six years should be charged with a part of its cost. If 
the scrap value of the machine is $100, the six years during 
which the machine has been used must be charged with 
$900 for its use. 

As to whether each year should be charged an equal 
amount, there is no unanimity of opinion. It depends 
upon the method of "depreciation" that is adopted. It is 
not deemed desirable at this time to enter into a discussion 
of the different methods which may be employed. It is 
important to see, however, that the estimated decrease in 
value of the asset due to the operations of the business each 
year must be charged against the income derived from these 
operations. 

Since the actual expenditures for any particular equip- 
ment take place at one time, and not during each year of its 
use, it is customary to credit the estimated depreciation of 
each period to a reserve for depreciation account and to 
debit an expense account for the same amount. When the 
asset is sold or discarded, it is charged against the reserve 
account. By this means the cost of equipment is charged 
against the income of the periods which benefit from its u§e. 



THE PLANT AND EQUIPMENT BUDGET 249 

The new equipment which is purchased to take the place of 
the old is charged to the asset account. 

Betterments 

When betterments are made, future periods will be 
benefited either through the increased efficiency of the 
equipment concerned, or through its longer life, and hence 
replacement costs are postponed. In either case, since 
future periods are to receive the benefit of such better- 
ments, they should bear the cost of the betterments. 
Hence betterments are charged to asset accounts and are 
not reflected in the expense accounts of the period in which 
they are incurred. 

It is often difficult to distinguish between a betterment 
and a repair. In many cases an expenditure is partly one 
and partly the other. To take a classic illustration, if a 
wooden roof is replaced by a slate roof, so much of its cost 
as would have been incurred if a wooden roof had been used 
will be treated as a repair, while the excess of the cost of the 
slate over a wooden roof will be treated as a betterment. 
In case of doubt, it is the practice of accountants to be con- 
servative and treat the expenditure as a repair. 

Additions 

Additions to plant and equipment are made for the bene- 
fit of future periods. Hence their cost is not charged to the 
period in which they are obtained but is distributed, by 
means of the periodical depreciation charge, over the pe- 
riods during which they are used. Consequently, additions 
are a capital and not a revenue charge. 

It must be realized, however, that as soon as additions 
are secured they give rise to revenue charges, since a charge 
for depreciation must be made at the end of each fiscal 
period to provide for their replacement. 



250 BUDGETARY CONTROL 

Capital vs. Revenue Charges 

From the foregoing discussion it can be seen that from 
the viewpoint of accounting, plant and equipment gives rise 
to two kinds of charges: 

1 . Those which are made to maintain the present equipment. Re- 

pairs and replacements are included in this group. These 
may be termed "maintenance " costs. They must be included 
in the periodical expense accounts; or to use technical termi- 
nology, they are "charged against revenue." Many authori- 
ties do not include provision for replacements (that is, the 
periodical depreciation allowance) as an item of maintenance 
cost. From the viewpoint of a maintenance budget, this in- 
clusion is desirable and no difficulty arises if the definition 
of maintenance precedes its use. 

2. Those charges which represent an addition to the assets of the 

business. Betterments and additions are included in this 
group. These are termed "plant and equipment costs." 
They are charged to the asset, or to use technical terminology, 
they are "charged to capital." 

Method of HandUng Maintenance Charges 

The preceding discussion has dealt with the method of 
recording these two classes of charges. The following dis- 
cussion will deal primarily with the method of exercising 
control over their amount. 

Maintenance charges on plant and equipment used in 
production are a part of manufacturing expenses and should 
be included in the manufacturing expense budget. This is 
necessary in order to judge the effect of the contemplated 
production program on the amount of the manufacturing 
expense. It is also necessary in determining costs of manu- 
facturing product and in the establishment of standard 
rates. 

It is desirable that the maintenance costs also be shown 
on the plant and equipment budget, since this makes it 
possible to obtain a comprehensive picture of the plant and 



THE PLANT AND EQUIPMENT BUDGET 251 

equipment program as a whole. Their appearance on the 
plant and equipment budget also facilitates the establish- 
ment of appropriations for them. If the manufacturing 
expense budget and the plant and equipment budget are 
prepared by different units of the organization, which is 
usually the case, the maintenance charges appearing on the 
two budgets can be checked against each other, which will 
tend to correct errors made by either party in making the 
estimate. If there is a disagreement between the estimates 
shown on the two budgets, this should be reconciled, if pos- 
sible, by the parties responsible for it. If this cannot be 
done, it will be necessary to submit the disagreement to the 
budget committee for settlement. 

It must of course be remembered that in preparing the 
financial budget and also the estimated statement of profit 
and loss, the cost of maintenance must be taken from only 
one budget. 

Requirements for Plant and Equipment Control 

To exercise effective control over disbursements for 
plant and equipment, three things are necessary: 

1. There must be available data which will show results of past 

operations and serve as the basis of future plans, 

2. After all the available data have been considered, the plans which 

have been formulated must be expressed in workable form by 
means of a budget on plant and equipment. Sometimes two 
budgets are made, one on maintenance costs and one on the 
cost of betterments and additions. The requirements for each 
are sufficiently similar to make their joint discussion possible. 

3. After the budget is made, it is necessary to have records and re- 

ports prepared which will make possible the control of such 
expenditures and the enforcement of the budget plans. 

Data Required as Basis of Control 

The data required to serve as a basis for control of plant 
^nd equipment expenditures may be classified as follows : 



252 



BUDGETARY CONTROL 



I. 



3- 
4. 



That which is obtained from the accounting and statistical rec- 
ords with reference to past experience. 

That which is obtained by a mathematical calculation based on 
predetermined factors. 

That which is determined by a consideration of future plans. 

That which is obtained as a result of the investigation and study 
of experts. 



Accounting and Statistical Data 

To make plans which will serve to control expenditures 
for plant and equipment, it is necessary that a proper classi- 
fication of the plant and equipment be made and that 
proper records be maintained which reflect this classifica- 
tion. This classification is necessary to make an accurate 
estimate of plant and equipment expenditures. 

To illustrate, in a manufacturing business the plant and 
equipment expenditures will vary with the production pro- 
gram. If production is to be increased it will be necessary 
to do one or both of two things: (i) secure additional equip- 
ment; (2) use present equipment more intensively. In 
either case, additional expenditures will be incurred, and to 
estimate accurately the amount of these expenditures it is 
necessary to consider carefully the various kinds of equip- 
ment used in production. 

If additional equipment is to be secured it will be neces- 
sary to determine the units of equipment used in the past 
and the amount of production which has been accomplished 
with this equipment. On this basis, the additional equip- 
ment required to secure the increased production capacity 
can be estimated. That the past production capacity may 
be obtained accurately, a record of each unit of equipment 
is necessary. 

If the present equipment is to be used more intensively, 
this will increase the maintenance cost, and an estimate of 
this increase must be made. It should be obvious that a 



THE PLANT AND EQUIPMENT BUDGET 253 

change in the production program will not affect all the 
equipment of the business to the same extent. For instance, 
it may be planned to increase the output of one department, 
while the output of all the remaining departments is to re- 
main the same. This increase in the output of one depart- 
ment is very apt to increase the maintenance expense of 
this department, and if the previous expense is shown sepa- 
rately from that of all the other departments, a more accu- 
rate estimate of the increase can be made. It will be 
necessary, however, to know more than the total cost of the 
maintenance of the department. The new program will 
probably affect some units of equipment in the department 
more than it will others. It is desirable, therefore, to have 
records which will show each unit of equipment in the de- 
partment, and the maintenance expense incurred on it. 
This is accomplished by keeping a plant ledger. 

Plant Ledger 

A plant ledger is a record which contains an account with 
each unit of plant and equipment. It serves as a subsidiary 
record to the controlling account or accounts with plant and 
equipment which are kept on the main ledger. The plant 
ledger is usually kept on cards or loose-leaf sheets, each card 
or sheet providing a record of one unit of equipment. The 
size of this unit will vary, depending on conditions. There 
may be a separate account for each machine, or if several 
machines of the same pattern and size are purchased at the 
same time, they may all be recorded in one account. 

Each account in the plant ledger should show at least 
three things: 

1 . The original cost of equipment and the date of purchase. 

2. The amount of depreciation which has accrued on the equipment 

to date. 

3. Its present book value. 



254 



BUDGETARY CONTROL 



In addition the account may show the amount of the repairs 
which have been made on the equipment to date. 

It will be understood that the repairs entered on the 
plant ledger account will not affect the value of the equip- 
ment, since they are treated as an expense and are never 



PLANT LEDGER 



Our 
Plant No.. 



Name of Item. 



Made 
_By_ 



Maker's 
No . 



Acct. 
_No._ 



_BIdg._ 



_Dept.. 



Indicate below whether machine 

proper, accessories, foundation, 

or additions, etc. 



FIXED ASSETS 



Detail 



Total 



DEPRECIATION RESERVE 



Date 



Rate 



Annual 



Total 



Figure 22. Plant Ledger 

added to the asset. It is useful to have them entered on the 
plant ledger account for memorandum purposes, so that in 
making future estimates it will be possible to obtain infor- 
mation of the past costs of repairs, not only in total but also 
by departments and by units. It is not within the province 
of this discussion to treat of the accounting features in- 
volved in the operation of a plant ledger, but it is necessary 



THE PLANT AND EQUIPMENT BUDGET 255 

to emphasize its usefulness in making plans for the control 
of maintenance cost. 

Figure 22 shows a typical form of plant ledger. 

Data Calculated from Predetermined Factors 

Later chapters will show that the various departmental 
estimates are combined for two purposes: 

1. To determine the estimated cash receipts and the estimated cash 

disbursements, and thereby formulate a financial budget. 

2. To determine the estimated revenues and the estimated expenses, 

and thereby formulate an estimated statement of profit and 
loss. 

In making all the departmental estimates, it should be 
borne in mind that every business desires to formulate a 
program which it is capable of financing and which will re- 
sult in the greatest possible profit. A financial budget and 
the estimated statement of profit and loss are the state- 
ments which answer the two questions which are most sig- 
nificant with reference to the budgetary program. And all 
departmental estimates must be made so that these two 
statements can be prepared. In the preparation of the es- 
timated statement of profit and loss, the periodical deprecia- 
tion charge is an important factor. Consequently it must 
be given careful consideration in the preparation of the 
plant and equipment budget. 

All equipment wears out in time and its replacement 
must be provided for. This provision is accomplished by 
charging a certain amount to the expenses of each budget 
period, and crediting a like amount to a reserve for depre- 
ciation. The accounting technique involved in the opera- 
tion of such a reserve account need not be dealt with here. 
It is sufficient at this time to see that the amount of such 
depreciation is an important element of the expense of 
operation and must be included in the plant and equipment 



256 BUDGETARY CONTROL 

budget. In the calculation of the depreciation charge, three 
things are considered: the original cost of the asset, its antici- 
pated life, and its estimated scrap value. By subtracting 
the scrap value of the asset from its original cost, it is possi- 
ble to determine the cost of the use of the asset during its 
period of life. This cost must be distributed over the period 
of its life in such a way that each budget period will be 
charged with its equitable share. 

Distribution of Depreciation Cost 

There is a difference of opinion as to how this cost should 
be distributed. Some contend that each budget period 
should be charged an equal amount; others contend that 
the earlier period should be charged more than the later 
periods, since the equipment is more efficient when it is new 
and the cost of repairs is less, while, when it becomes older, 
its efficiency decreases and the cost of repairs becomes 
greater. Other methods are also suggested, but it is not 
thought advisable to discuss them here. Whatever method 
of determining the periodical charge is used, once adopted 
it should be followed throughout the life of the equipment. 

The determination of the periodical charge is, therefore, 
merely a mathematical calculation. If it is decided to 
charge each period a uniform amount, it is only necessary 
to take the figures of past periods as a basis of the present 
period budget charge. If some other method is followed, 
the charge for the current period may be more or less than 
that of the previous period, but it will be a uniform increase 
or decrease and can be determined by a consideration of the 
predetermined factors previously mentioned. 

Effect of the Budget Program 

The accounting and statistical records show the past 
expenditures for plant and equipment, but as suggested by 



THE PLANT AND EQUIPMENT BUDGET 257 

the preceding discussion, a change in the volume of produc- 
tion affects both the maintenance charges and the charges 
for additions and betterments. It is necessary, therefore, 
to consider the effect of the budget program on each 
of these. 

There are many plans which may affect cost of mainte- 
nance. If a large increase in production is planned, the 
increased cost of maintenance arising from this increased 
production must be estimated. If new methods of manu- 
facture are to be employed, the consequent change in main- 
tenance cost must be calculated. If new equipment is to 
take the place of old, the maintenance cost will be affected. 
If it is planned to inaugurate a policy of keeping the equip- 
ment in better repair so as to make it more efficient and to 
prolong its life, this change must be considered. These as 
well as other factors affect the cost of maintenance, and all 
these factors must be considered. 

In considering the relation of maintenance cost to future 
plans, various comparisons should be made. This is due to 
the fact that some items of maintenance cost will vary in 
proportion to certain factors, while others will vary in pro- 
portion to different factors. To estimate these, it is neces- 
sary to determine the ratio of the volume of production to 
these costs during the past period or periods. By applying 
this ratio to the estimated volume of production for the 
current period, an estimate of these items of maintenance 
expense for this period can be obtained. Some items of 
maintenance cost will vary more nearly with the floor space 
used than with the production volume. Therefore, the 
ratio of floor space used in the past period to these items of 
maintenance expense during the same periods will be ob- 
tained, and this ratio applied to the estimated floor space of 
the current period. Other items of maintenance costs may 
vary in proportion to the number of units of equipment 

17 



258 BUDGETARY CONTROL 

which are used. Hence the amount of these items will be 
increased as the number of the units of equipment are in- 
creased. ' 

In the same manner in which the general plans of the 
business, as reflected in the departmental estimates, affect 
the cost of maintenance, they determine the amount of new 
equipment to be purchased. In a manufacturing business 
the amount of equipment required is determined primarily 
by the volume of production. If records are available 
which show machine capacity, such as were discussed in 
connection with the production budget, it is not difficult to 
estimate the requirements of the increased production in 
terms of number of machines or units of equipment. If 
proper records are maintained, it is possible to estimate the 
total requirements of the production program and the total 
production capacity of the factory. By a comparison the 
excess of requirements over capacity can be determined, 
and from this the new equipment required can be calculated. 

Information Obtained by the Investigation and Study of Experts 
It is desirable that a periodical check be made on the 
accuracy of the value of the plant and equipment as shown 
by the records. If a plant ledger is maintained in the form 
described in the preceding discussion, it is possible to obtain 
the original cost, the accrued depreciation, and the repairs 
incurred on each unit of plant and equipment. The depre- 
ciation shown as accrued is only an estimate, however, and 
the expenses which have been incurred may have been more 
or less than those required to maintain the equipment in an 
efficient condition. Unless some steps are taken to deter- 
mine the accuracy of the estimated depreciation and the 
sufficiency of the repairs which have been made, it may be 
determined in the future that both the depreciation and the 
repairs have been inadequate, and consequently there will 



THE PLANT AND EQUIPMENT BUDGET 259 

be an unduly heavy charge against the earnings of future 
years. 

To avoid this it is desirable that a periodical inventory 
or appraisal be made of plant and equipment and used as a 
means of checking the plant ledger and as a basis for budg- 
etary plans. By this means inaccuracies in depreciaton 
estimates and inadequate repairs can be discovered and 
corrected. It is also possible that too liberal depreciation 
may be allowed or too extensive repairs are being made. 
Such appraisals will serve to disclose this. They will also 
show when it is better to purchase a new machine rather 
than repair an old one. 

Although an appraisal of plant and equipment is quite 
valuable to use in the way indicated in the preceding para- 
graph, it must be used with discretion, especially if it is 
made by professional appraisers. The viewpoint of the 
professional appraiser is not always that of the accountant 
or that of the financial executive. The appraiser tries to 
determine the present value of the article he is appraising. 
He is concerned with its original cost and past use, only as 
they assist him in determining present value. As a con- 
sequence, market fluctuations are apt to be reflected in his 
appraisal. The accountant and financial executive, on the 
other hand, are not interested in the market value of the 
equipment. They are interested only in apportioning the 
original cost and the cost of repairs over the periods which 
will benefit from its use, in as equitable a manner as possible. 
An increase in the market value of the asset does not increase 
its life or its efficiency; neither does a decrease in its market 
value decrease its life or its efficiency. 

Because of these reasons, the value of the appraiser may 
not agree with the book value, and yet the book record may 
be satisfactory. The chief importance of the appraisal is 
not the value which it places on the asset, but rather the 



26o BUDGETARY CONTROL 

appraiser's estimate of the length of hfe and efficiency of 
the asset as reflected in the value placed on it. 

The Plant Engineer 

Many raanufacturing companies have on their staff a 
plant engineer, who is responsible for the production, use, 
and maintenance of plant and equipment. As indicative of 
the function of the plant engineer, the following responsi- 
bilities may be mentioned : 

1. The study of improved methods of factory construction. 

2. The study of present factory layouts, and presentation for the 

approval of the executive in charge of production, of proposals 
for improvements based on costs involved and savings made. 

3. The study of machinery, equipment, and tools, and the presenta- 

tion for the approval of the executive in charge of production, 
of proposals for changes, based on costs involved and savings 
to be made. 

4. The presentation of a periodical plant and equipment program, 

based on studies made in collaboration with the works plan- 
ning department and the works engineering department. 

5. The presentation of the plant and equipment program to the 

executive in charge of production, for approval and transmis- 
sion to the budget committee. 

6. The preparation of a periodical maintenance program as prepared 

by the works maintenance department and detailed by the 
works engineering department. 

7. The presentation of the maintenance program to the executive 

in charge of production, for approval and transmission to the 
budget committee. 

8. The supervision over the execution of the plant and equipment 

and the maintenance programs as approved by the budget 
committee. 

Where there is an efficient plant engineer performing 
the functions suggested in the above outline, the services of 
professional appraisers can usually be dispensed with under 
normal conditions. 



CHAPTER XVII 

THE PLANT AND EQUIPMENT BUDGET 

(Continued) 

Preparation of Plant and Equipment Budget 

The preceding discussion explained in considerable 
detail the data which serve as a basis for the preparation of 
the plant and equipment budget. It is now necessary to 
see how these data are formulated into a budgetary pro- 
gram which serves as a means of controlling plant and 
equipment expenditures. This involves a consideration of : 

1 . The contents of the plant and equipment budget. 

2. The responsibility for its preparation. 

3. The form in which it is made. 

4. The manner in which it is used. 

Contents of the Plant and Equipment Budget 

The plant and equipment budget can be made to show 
any information which the executives think is desirable for 
their use. It is usually thought desirable that it contain 
the following : 

1. The value of present equipment at the beginning of the period. 

2. The estimated depreciation and repairs on present equipment, 

3. The estimated cost of new equipment which should show: 

(a) Cost of factory equipment, and 

(b) Cost of equipment for administrative and selling units of 

the business. 

4. Estimated depreciation and repairs on new equipment. 

5. Total depreciation and total repairs on both old and new equip- 

ment. 

6. Value of total equipment at end of period. 

261 



262 



BUDGETARY CONTROL 



Responsibility for Preparation of Plant and Equipment Budget 

The executive in charge of production is responsible for 
the preparation of the plant and equipment budget so far 
as it relates to the factory. This responsibility he will dele- 
gate to the plant engineer, who in turn will employ the 
assistance of the works maintenance department and the 
works engineering department. In calculating the depre- 
ciation charges he will avail himself of the services of the 
accounting department as well. The cost records will also 
be of service in estimating the cost of repairs and construc- 
tion of new equipment. The purchasing department will 
assist in estimating the cost of new equipment which it is 
planned to purchase. 

In estimating the amount of equipment required it is 
necessary to make use of the estimate of production, since 
the quantity of production will affect the equipment re- 
quirements. If a plant engineer is not employed, the plant 
and equipment budget may be prepared by the staff of the 
production manager or by the planning department. The 
cost of repairs and depreciation will be estimated by the 
cost accounting department in the estimate of manufactur- 
ing expense, and this estimate may be used in preparing the 
estimate of plant and equipment, but it is preferable that a 
separate estimate be prepared by some unit of the produc- 
tion department. 

The office manager is responsible for the preparation of 
the estimate of equipment for the administrative and selling 
units. In its preparation he will employ the assistance of 
the heads of the departments and executive units. Each of 
these will submit a request to the office manager for the 
equipment which he desires during the next budget period. 
The office manager will consolidate these into one estimate 
and transmit it with his recommendations to the executive 
in charge of the budgetary procedure. 



THE PLANT AND EQUIPMENT BUDGET 



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The production manager will transmit the estimate of 
manufacturing plant and equipment to the executive in 
charge of the budgetary procedure, and the latter will 
transmit it together with the estimate of the office manager 
to the budget committee. After the committee has ap- 
proved these estimates, they will be returned to the pro- 
duction manager and the office manager, respectively. 

Form of the Plant and Equipment Budget 

No standard form for the plant and equipment budget 
can be described, for its form will depend upon the method 
employed in its preparation and use. Figure 23 is indicative 
of the information that the budget should contain. A sep- 
arate form may be used for factory equipment and for office 
equipment, but the information desired in the two cases 
is sufficiently similar to make the same form satisfactory 
in most cases. 

In filling in columns (4) and (8) the plant engineer will 
consult the works engineering department with reference 
to the cost of repairs. The works maintenance department 
will supply information with reference to the amount of 
repairs to be made. If the company produces its equip- 
ment, the works engineering department will supply the 
data needed for column (5). If the new equipment is to 
be purchased from outside vendors, the purchasing agent 
will supply these data. 

Column (6) on the plant and equipment budget states 
when the new equipment is desired. With this as a basis 
the purchasing agent will state the terms on which the goods 
will be purchased and show the date of payment. This 
information is necessary for the preparation of the financial 
budget. If the equipment is to be produced by the com- 
pany, an estimate must be made of the disbursements 
necessary for its production, The date given in column (6) 



THE PLANT AND EQUIPMENT BUDGET 265 

is the date when the complete equipment is desired. It 
may require a considerable period of time for its production. 
During the process of its construction expenditures for 
labor and possibly for materials will need to be made. 
Under such circumstances, the estimated expenditures pre- 
ceding the completion of the equipment must be determined 
and allocated to the proper period for the purpose of the 
financial budget. 

Execution of the Plant and Equipment Budget 

The budget for plant and equipment consists of an esti- 
mate of the expenditures necessary for maintaining the 
present equipment and the securing and maintenance of 
the additional equipment demanded by the budget program. 
Its approval is followed by the making of various appropria- 
tions for the necessary amount to cover the cost of the vari- 
ous items included in the budget. After these appropria- 
tions are raade, it is necessary to establish a procedure which 
will effect their enforcement. This procedure usually 
requires the following: 

1. That expenditures under any appropriation be made only after 

requisitions for these expenditures, accompanied by proper 
estimates of cost, have been submitted and approved by the 
proper authority. 

2. That careful costs be kept on all work done under appropriations. 

3. That reports be prepared showing a comparison between the 

estimated and actual cost of all such work performed. 

4. That reports be prepared monthly showing the status of all 

appropriations. 

Requisitions for Expenditures 

It is customary to delegate to some official of the com- 
pany the authority to grant expenditures under each ap- 
propriation. In many cases the expenditures are divided 
into two groups, known as "minor" and ''major," For 



i^ 



266 BUDGETARY CONTROL 

instance, any expenditure of less than $ioo may be termed 
a ''minor" expenditure, and any expenditure of more than 
$100 may be termed a "major" expenditure. The head of 
the production department may be given the authority to 
approve all minor expenditures for the production de- 
partment, and the office manager to approve all minor 
expenditures of the other departments. For the major 
expenditures the approval of the budget committee may be 
required. 

That the proper executives may exercise effective con- 
trol over the disbursements made under appropriations, it 
is necessary that the disbursements be made only as a result 
of a requisition or request on the part of the one desiring 
that repairs be made or additional equipment secured. 
When repairs or additions to plant or equipment are desired 
by any department, the head of this department should 
transmit a requisition to the production manager or the 
office manager, as the case may be. 

Such requests should be accompanied by an estimate of 
the cost of the repairs or additions. If equipment is to be 
purchased from outside vendors, it is easy to obtain the 
purchase cost and submit it with the requisition. If addi- 
tions to plant or equipment are to be constructed by the 
company, an estimate of the cost of the construction must 
be made. 

The estimate of the cost of repairs or construction which 
is to be done by the company can be made in two ways. 
If the business maintains an engineering department, this 
department can be asked to make an estimate. A compe- 
tent engineer learns by experience to estimate costs accu- 
rately. His estimates should be checked by statistics of past 
costs. If it is not possible or not desirable to have engineers 
make the estimate, it can be made by the cost accounting 
department, which will make the estimate on the basis of 



THE PLANT AND EQUIPMENT BUDGET 267 

the statistics obtained from the records of previous costs. 
These estimates may be erroneous if the one making them 
is not trained in mechanics. If cooperation between the 
accounting department and the engineering department is 
secured, more accurate estimates will be obtained. 

Costs of Construction and Repairs 

If the requisition calls for construction of repairs or 
equipment by the factory, there should be careful records 
kept of the cost of the construction. The method of de- 
termining these costs is very similar to the method of 
determining the cost of goods manufactured for sale. 
Each requisition, after it has been approved, is given a 
number, and a construction order is issued authorizing the 
construction called for by the requisition. The construc- 
tion order has the same number as the requisition. An 
account is opened on the cost records for the construction 
order and all costs incurred in the construction are charged 
to this account. 

It must be remembered that in arriving at the cost of 
construction a business cannot derive a profit from work 
done for itself. Hence no profit must be allowed on con- 
struction work performed by the company for itself. It 
may be possible that the company performs this work for 
less than it can secure it from outsiders. This results in a 
saving to the company, but it does not result in a profit. 

Reports on Construction Costs 

When a construction order is completed, a report is 
made to the executive having supervision over the expendi- 
tures for construction, showing the estimated cost and the 
actual cost. If there is any considerable variance, it is 
due to inaccurate estimates or excessive cost. With the 
comparative figures available it is possible to determine the 



268 BUDGETARY CONTROL 

cause of the variation. Unless such comparisons are made, 
it is impossible to exercise any effective control over the 
cost of construction work. 

A copy of these reports should go to the controller or 
head accountant, as well as to the production manager and 
budget committee. This procedure will provide a com- 
prehensive check on the costs of construction. 

Report on Appropriations 

To exercise effective control over the plant and equip- 
ment budget, it is necessary to have periodical reports 
which will make possible a comparison between the amount 
appropriated for each class of expenditures and the actual 
amount expended. A report should be made monthly, 
giving this comparison. This report should provide the 
information shown in Figure 24. 

A report made in this form is of service not only to the 
executive who is exercising control over the purchases and 
construction of plant and equipment, but also to the finan- 
cial executive. It shows the former the amount which he 
has available for future construction, and the latter the 
amount which he must plan to finance. The tenth column 
gives the treasurer information of special value, since it 
states the payments which must be made in the near future. 
Column (13) shows the amount which may be diverted to 
some other purpose in case of financial stringency. If the 
budget committee receives this report each month, it can 
exercise an effective control over all disbursements for plant 
and equipment. 

Reserve for Contingent Expenditures 

It is usually not possible to estimate exactly each item 
of plant and equipment cost which must be met during the 
budget period. There will usually be need for expenditures 



THE PLANT AND EQUIPMENT BUDGET 



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which cannot be foreseen. It is desirable to anticipate 
these additional costs and include an item in the plant and 
equipment budget of each period to cover them. Since 
these additional costs vary in amount from period to period, 
it is well to credit a reserve account for the amount provided 
for them in each budget. When the costs are incurred, they 
can be charged against the reserve. These additional costs 
may be due to rising costs of material and equipment, labor 
emergencies, accidents, increased production, and similar 
causes. 

By employing the method outlined above, these costs 
can be taken care of when they arise. It is obvious that 
this reserve has a limited use and must not be used as a 
means of hiding excessive amounts paid for construction or 
repairs during certain periods. If it is too large, it prevents 
the control being exercised for which the plant and equip- 
ment budget is intended. 



Use of Standardized Equipment 

There is a modern tendency to use standardized equip- 
ment throughout a business. Such standardization is 
especially desirable for furniture, fixtures, and office equip- 
ment. To that end businesses frequently select a standard 
type of desk, standard typewriters, and standard calculat- 
ing machines to be used in all offices. Any other type of 
equipment which is in general use should be standardized, 
if possible. Factory equipment should be standardized if 
practicable. 

There are several advantages in having standardized 
equipment, among which the following may be mentioned : 

I. By buying all equipment from one company, it may be possible 
to obtain more favorable terms. At least such buying pre- 
vents the purchasing of unduly expensive equipment by some 
departments when less expensive equipment would do as well. 



THE PLANT AND EQUIPMENT BUDGET 271 

2. It facilitates the purchasing of new equipment, since a requisi- 

tion can be made for one unit of equipment and sent to the 
general purchasing agent who knows what to purchase, from 
whom to purchase, and the cost of the same. This eliminates 
the preparation of specifications for the use of the purchasing 
agent and relieves him of the task of obtaining quotations on 
special types of equipment. 

3. It facilitates the production of equipment which the company 

produces for its use, since standard specifications can be 
prepared and the necessary materials and tools can be pro- 
cured in advance. It also facilitates the making of repairs, 
since piece parts can be kept on hand, and mechanics will 
become more skilled in making repairs. 

4. It facilitates future planning, for it is only necessary to estimate 

the number of units required and the cost can be easily 
obtained. 

5. It tends to promote the most economical use of equipment, since 

equipment can be moved from one office or one department to 
another, thus preventing a probable surplus in one and a 
shortage in another. 

6. In case of equipment which requires technical skill to operate, 

it facilitates the transfer of employees from one department to 
another. 

Review and Summary^ 

In the preceding pages, the procedure necessary for the 
preparation and execution of the plant and equipment 
budget has been outlined. In summary form, this proce- 
dure is as follows: 

I. Requirements for Control of Plant and Equipment: 

1. A proper analysis of plant and equipment expenditures to 

determine their classification and a record of them which will 
show correctly their effect on the financial condition of the 
business. 

2. A proper control of the amount expended for plant and equip- 

ment to the end that sufficient will be expended to provide a 

1 In this brief summary no attempt is made to indicate the organization necessary for plant 
and equipment control, this having been discussed in the preceding pages. 



2^2 BUDGETARY CONTROL 

well-equipped and efficient plant, and at the same time pre- 
vent the expenditures of more than is necessary to secure this 
result. 

II. Control of the Amount of Expenditures Required: 

1 . That data be available which will show results of past operations 

and serve as the basis of future plans. 

2. That plans be formulated on the basis of these data and be ex- 

pressed in workable form by means of a plant and equipment 
budget. 

3. That records be maintained and reports be made which make 

possible the enforcement of the budget formulated. 

III. Data Required as Basis of Control: 

1. Those which are obtained from the accounting and statistical 

records with reference to past experience. 

2. Those which are obtained by mathematical calculations based 

on predetermined factors. 

3. Those which are determined by a consideration of future plans. 

4. Those which are obtained as a result of the investigation and 

study of experts. 

IV. Plant and Equipment Budget Shows: 

1 . The anticipated repairs and estimated depreciation on the pres- 

ent plant and equipment. 

2. The estimated cost of new equipment including (a) cost of factory 

equipment, and (b) cost of equipment for administrative and 
selling units. 

3. The anticipated repairs and estimated depreciation on the new 

equipment to be secured. 

V. Records and Reports for Control of Plant and Equipment 
Budget Include: 

1. Requisitions for all purchases of equipment and for all construc- 

tion of equipment or repairs. 

2. Estimates of cost of purchases or construction which accompany 

the requisitions. 

3. Records of the cost of all construction or repair work performed 

by the company. 

4. Reports showing a comparison of estimates and costs. 

5. Reports showing a comparison of expenditures with budget 

allotments. 



CHAPTER XVIII 
THE EXPENSE BUDGETS 

The Expense Problem 

In the operation of a business it is necessary to incur nu- 
merous expenditures which in accounting and business 
practice are designated by the general term ''expenses." 
Expenses are incurred in connection with the operations of 
all the functional departments of a business. In the secur- 
ing of sales, expenses are incurred for salaries of salesmen, 
wages of clerical help, postage, stationery, supplies, and 
advertising. In the production of goods, heat, light, power, 
supplies, and miscellaneous labor must be purchased. In 
the maintenance of plant and equipment, repair and replace- 
ment costs must be borne. In the general administration 
of the business, expenses of various kinds are necessary. 

Although many expenses are incurred in small amounts, 
the sum total of all expenses in most businesses is sufficiently 
large to absorb a large percentage of the returns from sales. 
The amount of the expenses of a business is apt to deter- 
mine whether it operates at a profit or a loss. Its sales and 
its purchases are presumably made in a competitive market 
where it has the same advantages as its competitors. In so 
far as this is true, the gross profit of competing businesses 
should tend to be the same. But the expense element in 
different businesses varies widely, and in this fact lies to a 
large extent the explanation of the wide variations in the 
net profits. 

Because expenses are incurred by all departments of a 

business, are largely intangible in nature, and the individual 

items are small, their control is difficult. They have a 

tendency to increase constantly, and as they increase, the 

18 273 



274 BUDGETARY CONTROL 

profits of the business tend to decrease. To secure a con- 
trol of expenses which is effective and yet not unduly burden- 
some is one of the most important and difficult tasks of 
business management. 

Classification of Expenses 

One of the first steps in effecting a proper control of 
expenses is the establishment of a proper classification or 
grouping of them. It is obvious that administrative atten- 
tion cannot be given to each separate item of expense, and 
this fact necessitates that a classification be made which 
will make possible the focusing of executive attention on 
groups of related items. 

Expenses may be classified in many ways, depending on 
the purpose for which the classification is to be used. From 
the viewpoint of administrative control the following classi- 
fication is helpful: 

1. Manufacturing expenses, or those which are. incurred in the oper- 

ation of the factory and the production of the commodity or 
service which is offered for sale. 

2. Selling expenses, or those which are incurred in the marketing of 

the product produced or purchased for sale. 

3. Financial expenses, or those incurred in planning and controlling 

the receipt, custody, and disbursement of funds. 

4. Auxiliary expenses, or those incurred by the various auxiliary or 

"service" departments of the business, such as the accounting 
department, personnel department, purchasing department, 
and office manager's department. 

5. Executive expenses, or those which are incurred in the general 

administration of the business and cannot be charged to any 
of the foregoing groups. This group includes the expenses of 
the general manager and his staff. 

6. Corporate expenses, or those which are not incurred as a result of 

the operations of any particular department, but which are 
necessary that the business exist and operate as an entity. 
Directors' fees and expenses, capital stock tax, and income 
taxes are illustrations of such expenses. 



THE EXPENSE BUDGETS 



275 



This classification is different both in grouping and 
terminology from the usual accounting classification of 
expenses. The reasons for these differences will be explained 
when each class of expense is discussed. 

Relation of Expense Classification to Form of Organization 

The foregoing classification of expenses will be more 
readily seen if it is considered in connection with the chart of 



STAFF ASSISTANT 

IN CHARGE «• 

BUDGETARY 
PROGRAM 



PRESIDENT 

AND 

GENERAL MANAGER 



VICE-PRESIDENT 

IN CHARGE or 

PRODUCTION 



STAFF ASSISTANT 

TO 

PRESIDENT 



VICE-PRESIDENT 

IN CHARGE OF 

OPERATIONS 



VICE-PRESIDENT 

IN CHARGE OF 

SALES 



VICE-PRESIDENT 

IN CHARGE or 

FINANCE 



General 
Auditor 



Pfersonnel 
Manager 



Purchasing 
Agent 



Office 
Manager 



Credit 
Manager 



Cashier 



Figure 25. Organization Chart for a Manufacturing Business 

a typical organization of a manufacturing business which is 
shown in Figure 25. 

It will be understood that the chart of organization 
shown in Figure 25 is intended to be suggestive and not 
arbitrary. Scarcely any two businesses will have the same 
plan of organization. This is due to the differences in size, 
volume, nature of operations, and nature of personnel. In 
a mercantile business a merchandise department will take 
the place of the production department shown in the illustra- 
tion. In many businesses there will not be a vice-president 
in charge of operations to which some of the auxiliary de- 
partments report. Where the administration of personnel 



276 BUDGETARY CONTROL 

is regarded as a major function, the personnel manager may 
be given a more prominent position than is indicated in this 
chart. If the standards and record function is developed 
properly, there may be a controller who will combine under 
his jurisdiction several of the functions given in the fore- 
going chart. 

A form of organization which the author thinks is pref- 
erable to that given in Figure 25 is shown in Figure 26. 
The less preferable form is used as a basis for this discussion 
for it more nearly corresponds to the situation found in 
most medium-sized businesses. The primary purpose of 
introducing a chart of organization at this time is to indicate 
the desirability of classifying expenses to correspond with 
the classification of administrative activities maintained by 
a business as shown by its chart of organization. The 
significance of this method of classification will be more 
apparent as the discussion proceeds. 

Direct and Indirect Expenses 

There are some expenses which are incurred for the 
benefit of only one department, and these can be charged 
directly to that department. For instance, the salaries of 
the sales clerks can be connected directly with the opera- 
tions of the sales department and charged to selling expense. 
The repairs on factory equipment can be connected directly 
with the operations of the production department and 
charged to manufacturing expenses. These are known as 
"direct" expenses. 

There are other expenses which are incurred for the 
benefit of two or more departments and which cannot be 
charged directly to the expenses of any one department. 
For instance, the expenditures for light and heat are for the 
benefit of all the departments of a business. It is neces- 
sary to allocate these expenditures to the various depart- 



THE EXPENSE BUDGETS 



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278 BUDGETARY CONTROL 

ments which are benefited by them. These are known as 
''indirect" expenses. 

The expenses which are here termed indirect expenses are 
referred to by various names by writers and practitioners. 
They are called "overhead," ''burden," "non-productive," 
and by other terms. The terminology of accounting and 
business management is not standardized. It is impossible 
to use terms which have a uniform meaning and usage. 
The most that can be done is to define clearly those used 
and to limit their use to the definition given. 

Allocation of Indirect Expenses 

In most businesses the indirect expenses are of sufficient 
amount to make their allocation a matter of major impor- 
tance if a proper classification of expenses is to be main- 
tained, and accountants and industrial engineers have 
given much thought to this problem of allocation. Two 
questions arise from a consideration of the problem : 

1. What expenses should be allocated and to what departments? 

2. On what basis should the allocation be made? 

In answering the first question it is necessary to consider the 
purpose for which the allocation is being made; or to carry 
the inquiry one step farther, it is necessary to know for 
what purpose the data with reference to expenses are to be 
used. 

Allocation of Manufacturing Expenses 

Most of the discussion of allocation of indirect expenses 
in the past has dealt with the allocation of manufacturing 
expenses to classes of product, or to specific "jobs" or order 
lots. The purpose of this allocation is to obtain unit costs. 
The problem here is one of intra-departmental distribution. 
It is a question of distributing the total manufacturing ex- 
penses over the total product produced so that each unit of 



THE EXPENSE BUDGETS 279 

the product will bear its proportionate part of these expenses. 
Sufficient consideration is given to this problem in the chap- 
ter on the manufacturing expense budget. 

There is some question as to what should be included 
under manufacturing expenses, but this is not very im- 
portant. Because of the attention given to factory costs 
during the past few years, which has led to a careful consid- 
eration of what elements should be included in the determi- 
nation of those costs, there has developed a fairly uniform 
opinion as to what expenses should be classified as manu- 
facturing expenses. There are some items, such as interest 
on investment and rent, which are yet the subject of con- 
troversy. 

Allocation of Commercial Expenses 

Until recently there has been little attempt to apply the 
principles of costs, as developed in connection with produc- 
tion, to the determination of selling or "administrative" 
costs. There has been much attention given to the unit 
cost to produce, but little attention given to the unit cost to 
market or the unit cost of "administration." There are 
certain inherent difficulties which make the determination 
of such unit costs quite difficult, and in some cases there may 
be doubt of their usefulness. 

As a consequence of the failure to develop "commercial " 
costs, there has been much less attention given to the classi- 
fication of "commercial" or non-manufacturing expenses, 
than has been given to the distinction between manufac- 
turing and non-manufacturing expenses. 

Usually the "commercial" expenses which represent the 
difference between gross profit on sales and net operating 
profit, are grouped under the two general headings of "sell- 
ing" and ' ' administrative." All items which are not clearly 
selling expense are usually placed under administrative 



28o BUDGETARY CONTROL 

expense. In case of doubt with reference to any particular 
item, it is placed in the latter group which consequently 
conies to contain a great ruany items of a miscellaneous 
nature. Subclasses may be maintained under each of the 
major groups of selling and administrative expense, but 
usually no great care is exercised in the allocating of expenses 
between the subclasses. 

As a consequence of these practices, there has been a 
decided tendency to slight the question of allocating indirect 
commercial expenses. When such allocation has been made, 
it has frequently been on an unscientific basis. Depart- 
ment stores and some few other businesses have broken 
away from the traditional policy and given careful consid- 
eration to the allocation of these expenses, but such a prac- 
tice has been the exception rather than the rule. 

Relation of Expense Allocation to Organization of Business 

It can be seen from the foregoing discussion, that the 
consideration of expense allocation has been confined largely 
to manufacturing expenses and has here been limited in the 
main to a consideration of their allocation as a basis for 
unit costs. Unit costs are useful and desirable, but in the 
desire to obtain them there has sometimes been a tendency 
to overlook one of the important purposes of cost statistics. 
It is not sufficient to know what costs are — in addition it is 
necessary to control costs so that they will be as small as 
possible. 

In the modern business organization, control is exercised 
through individuals who compose the organization. If con- 
trol of expenses is to be effected through members of the 
organization, it is necessary that they be classified so as to 
show the responsibility for each class. If responsibility is 
taken as the controlling factor in an expense classification, 
each department will be charged with those expenses over 



THE EXPENSE BUDGETS 28 1 

which the executive head of the department exercises con- 
trol. In addition it may be charged with some items of 
expense the amount of which is fixed or at least is beyond 
the control of any officer. 

To illustrate, the production department will be charged 
for the supplies used in production, for these are under the 
control of the production manager, and in addition it will be 
charged with the depreciation on production equipment, 
the estimated amount of which is determined in most cases 
by others than the production manager. The depreciation 
should be treated as a manufacturing expense, for it is a 
direct result of the operations of the production department 
and is necessary to the proper performance of the produc- 
tion function. The production manager could not affect its 
amount if the duty of determining it was left to him, for its 
amount is determined by definite factors such as cost, scrap 
value, and estimated life. 

Expenses Which Should Not Be Allocated 

As an illustration of the type of expenses which it seems 
better not to allocate to a department, the salaries and 
expenses of the president and his staff may be mentioned. 
It is sometimes contended that as the president supervises 
and directs all the departments of a business, his salary and 
that of his staff should be allocated to the functional depart- 
ments. For instance, a portion of these expenses should 
be charged to selling expense. It seems that such a policy 
is unwise, since such salaries are variable amounts, subject 
to the wishes of the president and the board of directors and 
are not directly or indirectly under the control of the sales 
department. If these salaries are increased, the sales ex- 
pense will be increased and the sales manager is powerless to 
prevent it. 

The author can recall one case in which the compensa- 



282 BUDGETARY CONTROL 

tion of the sales manager was affected by the ratio of selHng 
expense to sales. After the passage of the income and 
excess profits tax law of 191 7, the corporation increased the 
salaries of some of its executives. The corporation is a 
close one and certain of the executives are the principal 
stockholders. Large salaries were thought to be better 
than large profits. The sales manager had put forth an 
unusual effort to increase his sales for the year 1918 with 
unexpected success. But when the increased salaries had 
been allocated to the departments, the sales expense was so 
increased that the bonus of the sales manager was smaller 
than the year previous, despite the unprecedented increase 
in sales. 

It is admitted that the foregoing is an extreme case, but 
it illustrates an important principle. If a department is 
charged with variable expenses over which its executive 
head and his assistants have no control, the value of the 
departmental expense reports as a basis of administrative 
control is largely destroyed. Expenses, like sales, produc- 
tion, and purchases can be adequately controlled only when 
estimates are made by those responsible for their amount 
and these held responsible for the attainment of these esti- 
mates. Such a procedure is greatly weakened if executives 
are held responsible for expenses over which they do not 
exercise control. 

The first question asked with reference to expense 
allocation may be answered by saying that no expense 
should be allocated to a department if such allocation 
will affect in a material way the fixing of responsibility 
for the expenses of the department on its executive head. 
There are of course cases where expediency will dictate 
a variation from the application of the general principle, 
but such variations should be permitted only for good 
reasons. 



THE EXPENSE BUDGETS 283 

Basis of Allocating Expenses 

With reference to the basis of allocation, it is beyond the 
province of this discussion to enter into any detailed dis- 
cussion of this question. Cost accountants have given much 
consideration to the allocation of manufacturing expenses 
to factory departments and manufacturing orders. The 
reader will find in the standard works on cost accounting 
able discussions of the various methods employed. Much 
less attention has been given to the proper basis for the allo- 
cation of commercial expense, although, as already stated, 
considerable has been done in this connection by depart- 
ment stores. 

The factory cost accountant in the early development of 
factory costs found the easiest method of distributing manu- 
facturing expenses to be on the basis of direct labor. In a 
similar manner the mercantile cost accountant found the 
easiest method of distributing commercial expenses to be on 
the basis of sales. Consequently, sales have been used very 
extensively by department stores as a basis for allocating 
expenses to the various departments of the store. But the 
factory cost accountant has found that the distribution of 
expenses on the basis of labor often gives incorrect results, 
and the commercial cost accountant has found that the 
distribution of commercial expenses on the basis of sales 
may give results equally unsatisfactory. 

To illustrate, one of the largest items of expense to be 
allocated in a department store is advertising. Formerly 
the usual method of allocating this to the various depart- 
ments of the store was on the basis of sales. This practice 
leads to two undesirable results. First, some departments 
profited much more than others by the advertising, since it 
was devoted to articles sold by some departments much 
more than to articles sold by other departments. For in- 
stance, the advertising of ladies' ready-to-wear clothing will 



284 



BUDGETARY CONTROL 



usually be much more extensive than the advertising of 
groceries. Yet the sales of the grocery department may be 
larger than the sales of the ladies' ready-to-wear department ; 
hence, according to the system of allocation based on sales, 
it may be charged more for advertising. This gives inac- 
curate figures, and if the departmental heads are paid a 
bonus on profits, it leads to an unfair charge against the 
profits of the head of the grocery department. Secondly, 
if advertising is distributed on the basis of sales, each de- 
partmental head will try to secure as much advertising as 
possible, since he will feel that each of the other departments 
must pay part of its cost which results in his department's 
paying only a small part of the total. He naturally con- 
cludes that he must certainly get more benefit from the 
advertising than it costs him; therefore he will request and 
urge it. He will be the more apt to do this because he 
knows every other department is seeking advertising, for 
which his department must pay its proportionate part. 

To be more concrete, the head of Department A may be 
contemplating a certain amount of advertising of the arti- 
cles sold by his department, which will cost $500. If the 
entire $500 were to be charged against his department, he 
might decide immediately not to request its expenditure. 
If, however, there are ten departments and he knows that 
on the basis of sales only $60 of the cost of the advertising 
will be charged against his department, he will feel that it 
must certainly be worth more than that to him; so he will 
urge that it be done. The tendency, therefore, will be for 
the ratio of advertising to sales to increase constantly. Of 
course, a capable advertising manager or merchandise man- 
ager may check this tendency, but it will have to be guarded 
against constantly with a strong probability that the adver- 
tising will be larger despite this vigilance. 

The brief consideration given to the method of allocat- 



THE EXPENSE BUDGETS 285 

ing indirect expenses affords a basis for the statement of the 
general principle that care should be exercised to allocate 
them in such a manner as to attain two results : 

1. Greatest possible accuracy. 

2. The fixing of responsibility in such a manner that those respon- 

sible for the expense will desire to decrease and not to increase 
it. 

Selling and Manufacturing Expenses 

The foregoing discussion has stated the general classifi- 
cations or groups into which expense may be divided for 
purposes of administrative control, and the general principles 
which should govern the allocation of expenses between 
these groups. It is now necessary to discuss briefly the 
contents of each of these groups. 

The composition of selling expenses and manufacturing 
expenses, and the method of exercising control of their 
amount, have been discussed in connection with the selling 
expense budget and the manufacturing expense budget re- 
spectively. It is not necessary to discuss these classes of 
expense further. They are included in the classification 
given at the beginning of this chapter in order that the 
reader might have a comprehensive picture of the expense 
problem. 

Financial Expenses 

The financial department, of which the treasurer is 
usually the executive head, incurs expenses in planning and 
executing the financial program. In many cases the credit 
and collection departments are under the control of the 
treasurer, in which case the expense of maintaining these 
departments will be treated as a financial expense. Finan- 
cial expenses can usually be grouped under two major 
classes: (i) office expense, and (2) credit and collection ex- 



286 BUDGETARY CONTROL 

pense. The first will include the salaries of the treasurer and 
his assistants, including the cashier, and the cost of main- 
taining his office. The latter will include the cost of the 
services and supplies of the credit and collection department. 
There has been a tendency in the past to place the cost 
of maintaining the financial department under the general 
heading of *' administrative" expense. This tendency is 
probably due to the fact that the president in many small 
companies acts as treasurer. Even when a treasurer is 
appointed, he is often regarded as assistant to the president. 
It seems that, regardless of whether there is a separately 
organized financial department, the financial function is of 
sufficient importance to merit the showing of its costs as a 
separate expense. This is particularly important from the 
viewpoint of budgetary control where the aim is to have a 
budget prepared for each functional department. 

Auxiliary Expenses 

The expenses which will be included in this group will 
depend on the organization of each particular business. In 
a business organized in accordance with the chart in Figure 
25, the expenses incurred in maintaining the accounting, 
personnel, office manager's, and purchasing departments will 
be included in this group. In a business organized in accord- 
ance with Figure 26, this group of expenses would not 
appear, since there are no auxiliary departments. Instead, 
there will appear the two major groups, controller's expense 
and personnel expense. 

Where the auxiliary departments exist, the expenses 
charged to each department will include the cost of the serv- 
ices and supplies used by the department. Sometimes the 
expense of maintaining these departments is allocated to the 
major departments of sales, production, and finance. From 
the viewpoint of budgetary and administrative control it is 



THE EXPENSE BUDGETS 287 

desirable, if these departments exist as separate units of 
organization, that the expense of each be shown as a separate 
group, in order that the responsibility for this expense may 
be placed on the executive head of the department. 

Executive Expenses 

The "executive" expenses should include those which 
are incurred by the executives of the business who do not 
devote their services to any particular department, but ren- 
der service to all the departments in the way of direction and 
supervision. This will include the salaries of the president 
and his staff assistants and the cost of maintaining their 
offices. Where a general office is maintained which is sepa- 
rate and distinct from the functional departments, these 
expenses are frequently termed "general office" expenses. 

Unless care is taken to exercise control over such expense, 
there is a tendency for it to increase unduly. One reason 
for this tendency is that the president of the company is 
usually vested with the control of the expenditures incurred 
in the general office and it is somewhat difficult for him to 
act as criterion of his own expense. It is desirable that the 
amount of this expense be presented to the board of direc- 
tors in such form that they can easily judge of its advisa- 
bility. The board of directors is the immediate superior 
of the president and therefore is the proper party to pass 
on his expenses. 

The need for presenting these expenses to the board of 
directors for careful inspection is another argument against 
allocating them to the various operating departments, since 
this tends to obscure their amount and to prevent a careful 
control of them. The treatment of these expenses as a 
separate and distinct classification also facilitates their 
budgeting in the same manner as the other expenses of the 
business. 



288 BUDGETARY CONTROL 

Corporate Expenses 

"Corporate" expenses, as that term is used in this dis- 
cussion, include those which must be incurred not because 
of any functions which the corporation exercises, but be- 
cause of its existence as a corporate organization and its rela- 
tion as such an organization to governmental bodies and 
parties outside the corporate organization. These expenses 
comprise corporation fees paid to the state government, 
capital stock taxes, directors' salaries and fees, expenses 
connected with the maintenance of stock registers and divi- 
dend records, and fees paid for professional counsel in con- 
nection with appraisals, business reports and audits required 
by creditors. The laws of most states impose on corpora- 
tions obligations in the way of making reports, the main- 
tenance of records, and the payment of fees. In the prepa- 
ration of some of these reports, such as income tax returns, 
and also in the preparation of reports to creditors, it may be 
necessary to obtain professional counsel from attorneys, 
accountants, and industrial engineers. These costs are 
obtained for the benefit of the business as a whole and should 
be shown as a special group. 

In many businesses a general group of expenses known 
as "administrative" expenses, is maintained, and in this 
group are placed what in this discussion are classed as 
(i) financial expenses, (2) auxiliary expenses, (3) executive 
expenses, and (4) corporate expenses. In such cases tlje 
items here termed "corporate" expenses are usually shown 
under the heading of "general administrative expense." 
This method does not provide for an effective control of 
expense on the basis of responsibility, which we have pre- 
viously seen is necessary for both administrative and 
budgetary purposes. The terminology suggested in the 
foregoing discussion may not be the best possible, but 
the general procedure outlined is one which will provide 



THE EXPENSE BUDGETS 289 

a proper basis for effective administration of the expense 
problem. 

Relation of Stores Budget and Pay-RoU Budget on the Expense 
Budgets 

In previous chapters the stores and pay-roll budgets 
have been discussed. When these budgets are prepared it 
is possible to eliminate the departmental expense budgets, 
with the exception of the manufacturing expense budget 
and the possible exception of the general office expense 
budget and the selling and advertising expense budget. 
The supplies used by each department will be included 
in the stores budget, and the salaries of the employees will 
be included in the pay-roll budget. 

Both the advantages and disadvantages of this proce- 
dure have been discussed in previous chapters and need not 
be repeated here. 

Budgetary Control of Expenses 

To provide an effective control of the expenses of the 
various departments as well as to provide the necessary data 
for the financial budget, it is necessary to adopt a procedure 
which contains the essentials of the following: 

1. Before the beginning of each budget period, an estimate is pre- 

pared by the executive head of each department or unit, show- 
ing the anticipated expenses of this department or unit for the 
next budget period. It is sent to the execv tive in charge of 
the budgetary procedure. 

2. All these estimates are used by the executive in charge of the 

budgetary procedure, probably with the assistance of the 
treasurer, in preparing a financial budget and an estimated 
statement of profit and loss. 

3. The estimates are submitted by the executive in charge of the 

budgetary procedure to the budget committee or to the board 
of directors, or to both, and after they are revised by the budget 

19 



290 BUDGETARY CONTROL 

committee or board of directors where deemed necessary, an 
appropriation is made to meet the expenses called for by each 
estimate. 

4. The amount of each appropriation as determined by the budget 

committee or by the board of directors, is communicated to the 
executive responsible for the original estimate. 

5. A monthly report is made to the budget committee or the board 

of directors through the executive in charge of the budgetary 
procedure, showing the status of each appropriation. 

6. The original appropriation must not be exceeded by any depart- 

ment without the permission of the budget committee or the 
board of directors. 

Responsibility for the Preparation of Expense Estimates 

To insure the effective operation of the budgetary pro- 
gram, it is necessary that definite responsibiUty for the 
preparation and enforcement of the expense budgets be fixed. 
The sales manager and the production manager will be re- 
sponsible for the preparation of the estimate of selling and 
advertising expense and the estimate of manufacturing 
expense, respectively. Their responsibility in this connec- 
tion has been explained in previous chapters. 

The treasurer will be responsible for the preparation of 
the estimate of expenses for the financial department. He 
will require the preparation of estimates by the head of 
the credit and collection department and by the cashier, 
which he will use in preparing the estimate for the whole 
department. 

The head of each of the auxiliary departments, such as 
the accounting, personnel, purchasing, and ofhce manager's 
departments, will be responsible for the estimate of his de- 
partment. He may employ assistants in its preparation 
at his discretion, but the responsibility for its preparation 
will rest upon him. 

The president is responsible for the preparation of the 
estimate of executive expenses. This duty he probably 



THE EXPENSE BUDGETS 29 1 

will delegate to his staff assistant, and this assistant may 
employ the aid of other officers in the office of the president. 
The estimate of corporate expenses will be prepared by 
the official designated by the president. This estimate may 
be prepared by the secretary of the corporation, since he is 
conversant with the relations which give rise to these ex- 
penses. In some cases this estimate is prepared by the 
treasurer; but if this practice is followed, care must be exer- 
cised to keep the estimate entirely separate and distinct 
from the estimate of expenses of the financial department 
as prepared by him. 

Form of Estimate 

The work of the executives who are responsible for the 
consideration of the departmental estimates is greatly fa- 
cilitated if these estimates are presented in a form which 
shows comparisons between the estimates and past expenses. 
Usually it is desirable that the form provide at least the in- 
formation called for by the columnar headings shown by 
Figure 27. 

By a consideration of the estimates when submitted in 
this form, the executives can see whether an increase of 
expenditures is called for, and if so, they can investi- 
gate to see if this increase is justified. The estimates as 
submitted by the various departments will show the salaries 
to be paid to the employees of these departments and the 
amount of supplies to be consumed during the budget period. 
The supplies used by all the departments of the business are 
usually purchased by a central purchasing department. 
The purchasing agent buys these in the quantities which he 
thinks are most economical, and consequently there may be 
at any time a considerable inventory of supplies on hand. 
The supplies consumed during any period, therefore, will 
not correspond with the supplies purchased in that period. 



292 



BUDGETARY CONTROL 



After the departmental estimates are made, it is neces- 
sary that these be sent to the purchasing agent, who, on the 
basis of the estimated consumption by the various depart- 
ments, will estimate the purchases which must be made, 
taking into consideration the terms on which these will be 



EXPENSE BUDGET 


ITEM 


Expenses 
for Past 
Budget 
Period 


Estimated 

Expenses 

for Current 

Period 


Per Cent 

of 
Increase 

or 
Decrease 


Average 
Expense 
for Past 

Four 
Periods 


DISTRIBUTION 


First 
Month 


Second 
Month 


Third 
Month 


Etc. 
















































Figure 27. Expense Budget 

secured, and will thus determine the disbursements for sup- 
plies for each period. The estimated disbursements are 
necessary as a basis for the preparation of the financial 
budget. 

Monthly Reports 

To effect a proper control of the appropriations made for 
each department, it is necessary to have prepared monthly a 
report which will show for each department a comparison 
between the expenditures of the department to date and the 



THE EXPENSE BUDGETS 



293 



appropriation for expenses of the department. Usually 
the accounting department prepares a report showing the 
actual expenditures of each department, and the executive 
in charge of the budgetary procedure prepares the report 
showing a comparison of the expenditures with the appro- 
priation. 

A difficulty which may arise from this method is the 
failure of the accounting department to prepare the monthly 



MONTHLY REPORT ON EXPENSE APPROPRIATION 


ITEM 


No. of 
Appro- 
priation 


Original 
Amount 


Addi- 
tions 


Deduc- 
tions 


Final 
Anriount 


Cash 
Dis- 
bursed 


Accounts 
Payable 


Undis- 
bursed 
Balance 


- 


















' 














~~~~ 





Figure 28. Monthly Expense Appropriation Report 



report in sufficient time to provide for a current check upon 
the monthly expenditures of the departments. To be of 
service, the budget committee should receive these com- 
parative reports shortly after the end of the month. If 
undue delay is caused by depending on the accounting de- 
partment, it may be necessary to have each department 



294 BUDGETARY CONTROL 

keep a special record of its expenditures and report these at 
the end of the month to the executive in charge of the budg- 
etary procedure. 

It is desirable that the monthly report on departmental 
expenses contain at least the information shown in Figure 28. 

Review and Summary 

In the preceding pages the procedure necessary for the 
preparation and execution of the expense budgets has been 
outlined. In summary form the procedure is as follows: 

I. Classification of Expenses: 

1. The setting up of an expense classification which corre- 

sponds to the classification of activities maintained by 
the business as shown by its organization chart. 

2. The allocation of indirect expenses in such a manner as to 

indicate the responsibility for their incurrence. 

3. The establishment of subclassifications under the major 

classes, which will enable the definite fixing of respon- 
sibility and a comprehensive explanation of variations. 

II. Preparation of Budgets: 

1. The preparation of an estimate of the expenses of each 

department for each budget period by the executive 
heads of the department. 

2. The transmission of this estimate to the budget committee 

or the board of directors for consideration and approval. 

3. The making of an appropriation by the budget committee 

or the board of directors to meet the estimate as ap- 
proved. 

III. Control of Budgets: 

1. The preparation of a monthly report showing a comparison 

between the actual and estimated expenditures. 

2. The consideration of this report by the budget committee 

or the board of directors, and the making of such re- 
visions in the original appropriations as may be found 
necessary. 



CHAPTER XIX 
THE FINANCIAL BUDGET 

Importance of Financial Planning 

Financial planning is the essence of financial adminis- 
tration. Without such planning the success of a business 
is a matter of accident. Many businesses, especially small 
ones, fail to plan ahead with reference to their finances and 
to this fact many of the business failures are due. 

The reports of the credit agencies show that the princi- 
pal cause for failure of business firms is ''lack of capital." 
This lack of capital in many cases could have been prevented 
if financial requirements had been estimated and plans made 
in advance to meet these requirements. The failure of 
these firms was due to the fact that they waited until the 
capital was urgently needed before attempting to secure it, 
and then they were unable to get it. In many cases its 
urgent need arose from the undertaking of plans which were 
beyond the capital capacity of the businesses and which 
would not have been undertaken if the managers had known 
in advance the financial requirements to which they would 
give rise. 

Mr. Walter H. Cottingham, President of the Sherwin- 
Williams Company, writing in the May, 1920 System, very 
aptly says: 

The small business does not raise additional funds easily. In 
fact, no money is raised "easily" — it has to be bargained for. But 
I think a part of the smaller man's difficulty may be traced to two 
reasons. The first is a lack of planning ahead and of a consequent 
scheduling of monley requirements for at least several years in ad- 
vance. This carelessness naturally results in a panicky getting of 
money, only when it is urgently needed. The second difficulty is in 

295 



296 



BUDGETARY CONTROL 



analogy: because he has not planned the owner has no clear, com- 
prehensive idea of just what he can afford to pay for money and is 
likely to insist upon too low a price until suddenly he finds himself 
"up against it." Then he pays too high a price — if he gets the 
money at all. 

The foregoing quotation emphasizes the necessity of 
financial planning for the small business, but its need in the 
large business is no less imperative. The principles dis- 
cussed in the following pages are applicable equally to the 
small and the large business, although in discussing proce- 
dure a business of sufficient size to make expedient a func- 
tional division of administrative duties is assumed. 



Need for Financial Program 

The operations of all the departments of a business 
necessitate the use of services and supplies, and the pur- 
chase of these necessitates the expenditure of funds. As 
a result of the operations, a service or commodity is pur- 
chased or produced, and this commodity or service is sold. 
From these sales, funds are received either immediately or 
at the expiration of the period of credit which is granted to 
customers. The typical cycle may be stated as follows: 
cash-supplies and services-sales-accounts receivable-cash. 

It can be seen, therefore, that the operations of a busi- 
ness result in the constant receipt and disbursement of funds. 
These funds are in the form of cash or the equivalent. - Since 
a business cannot continue to operate unless it is able to 
pay its obligations, it is necessary for its operations to be 
so planned that its cash receipts will be equal to its cash 
disbursements. 

The ideal financial program would be one which pro- 
vided for the receipt each day of the same amount of cash 
which must be disbursed on that day. It is impossible to 
make plans which are sufficiently exact to make possible 



THE FINANCIAL BUDGET 297 

such a schedule of receipts and disbursements, and so it is 
necessary to maintain a ''cash balance" which will insure 
against a discrepancy between the cash receipts and the 
cash disbursements. The cash balance in financial opera- 
tions serv^es a function similar to that performed by the 
merchandise inventory in merchandise operations. 

The custody of the cash receipts, the maintenance of 
the cash balance, and the control of the cash disbursements, 
are among the most important functions of a business. To 
accomplish these functions it is necessary that the cash 
requirements of a business be determined in advance and 
that well-formulated plans be made for the satisfaction 
of these requirements. 

Long-Time vs. Short-Time Financial Planning 

In the foregoing discussion it has been stated that a 
business should follow a far-sighted policy and plan its 
financial requirements several years in advance. This is 
undoubtedly true, but it must be obvious that such long- 
time plans can be made only in a general way and that they 
will indicate the capital requirements only by setting up 
certain maximum and minimum limits. For instance, a 
manufacturing firm may plan on the expansion of its busi- 
ness over a period of five years and estimate the additional 
plant, equipment, and working capital which it will need 
if the contemplated expansion is realized. It may secure 
the authorization of sufficient stocks or bonds to provide 
the maximum amount of capital required by its program, 
and may take such steps as are possible to assure itself that 
it will be able to issue these as capital is needed. But if its 
program fails of realization, it will not issue all the stocks 
and bonds authorized; or if conditions change so that 
their issuance is impossible or unprofitable, it will curtail 
its program. 



298 BUDGETARY CONTROL 

On the other hand, a business can plan its immediate 
capital needs with fair exactness, and it must estimate 
these needs if it is to assure itself that the capital to meet 
them will be available. It may be impossible for a business 
to know exactly the capital it will need to finance the sales 
which it expects to obtain three years hence, but it can 
know quite definitely that if bank loans are falling due dur- 
ing the next month which are in excess of its possible cash 
receipts from customers, it must renew these loans or obtain 
sufficient funds from other sources to pay them. 

For the present we shall be interested in a consideration 
of the short-time financial plans of a business. But the 
general principles discussed are in the main applicable to 
the planning for long-time capital needs. 

Determination of Cash Requirements 

In the past most business executives prepared their 
estimates of financial requirements on the basis of the re- 
quirements of previous years, taking into consideration 
in a rough way such factors as the amount of business ex- 
pected for the coming year, business conditions, and any 
plans that may be under way for the extension of plant, 
equipment, etc. The method by which these factors were 
taken into consideration is perhaps not improperly to be 
described as "expert guesswork" in the majority of cases. 
The length of time for which any such estimate is made will 
depend on the conditions in the particular line of business 
in question, though six months and a year have been the 
most usual periods. 

Such a plan as this is about all that is possible where 
a thoroughgoing departmental budget system has not been 
established, under which each department makes up a for- 
mal estimate of requirements and possible achievements, 
all to be organized by the chief executive in consultation 



THE FINANCIAL BUDGET 299 

with the departmental heads, into a single consistent plan 
for the budget period. Where such a budget system is in 
existence, each departmental budget can be made to show, 
among other things, the estimated cash requirements and 
estimated cash receipts. 

It is important to bear in mind that all budgets, from 
the point of view of executive control, fall roughly into two 
classes, though the budget made by one department may 
be composed of elements of both. One of these types is an 
estimate of requirements for conducting the activities of 
the department along the line proposed, that is, a requisition 
for supplies, materials, labor, equipment, etc. After it is 
approved it is in the nature of an allotment, that is, not to 
be exceeded without permission. The various expense 
budgets are good illustrations of this type. They request a 
certain amount of services and supplies to carry on the oper- 
ations of the departments for which they are made. 

The other type is a statement of the proposed accom- 
plishments of the department, a tentative promise to de- 
liver materials, services, etc., which, upon being accepted 
as a part of the general plan of the business, comes to be a 
quota to be attained. The sales budget, which states the 
sales which the sales department agrees to secure, and the 
production budget, which states the volume of production 
which the production department promises to deliver, are 
illustrations of this type. 

That which from the point of view of one department is 
a quota, from the point of view of another may be an allot- 
ment, and it is through this dovetailing of quota and allot- 
ment that a budget system seeks to coordinate the activities 
of all the departments of an organization into a single 
unified policy. For instance, the volume of finished goods 
stated on the production budget is a quota for the pro- 
duction department, but it is an allotment to the sales 



300 BUDGETARY CONTROL 

department, since it states the goods which the latter has 
for sale. The materials budget is an allotment to the 
production department, since it states the materials it will 
have available for use, but it is a quota for the financial 
department, since it states the funds which the latter must 
procure to meet the disbursements called for by the budget. 
Applying this distinction to the financial budget, each 
departmental estimate of cash requirements, when ap- 
proved, comes to be an allotment of cash to that depart- 
ment. In the same manner a departmental estimate of 
cash receipts becomes a cash quota for that department. 
In many businesses the sales estimate is the only one which 
represents anticipated cash receipts. 

Relation of Financial Budget to Departmental Budgets 

Sometimes the financial budget is wrongly regarded as 
a departmental budget. This may probably arise from 
the fact that it is often prepared by the treasurer. From 
the foregoing discussion it can be seen that this view is 
clearly erroneous. The financial budget is not a budget 
of the treasurer's department, but a combination of the 
budgets of ail the departments. The financial budget 
must state the funds which are needed to finance all the 
activities of a business, and these activities are stated in 
the departmental budgets. 

Some business firms have attempted to make a financial 
budget without making careful departmental budgets. 
In these cases the treasurer or controller prepares estimates 
of cash receipts and disbursements based on past operations 
and such contemplated changes of which he is cognizant. 
This procedure has usually resulted in unsatisfactory re- 
sults for two reasons : 

I. The financial budget cannot be made accurately without the 
use of the departmental estimates, for it is impossible for 



THE FINANCIAL BUDGET 301 

the treasurer or controller to know accurately the plans of 
all the departments. 
2. It is necessary to control the activities of the various depart- 
ments in order to enforce or carry out the financial budget, 
and this can be done only through the departmental budgets. 
It is obvious that if the disbursements of any department are 
shown on the financial budget, a departmental budget must 
be established so that the disbursements of this department 
will not exceed the amount stated. 



Determination of Cash Receipts 

In estimating the cash receipts of a business, it is neces- 
sary to determine all sources from which cash may be ob- 
tained. The number and nature of these sources will de- 
pend on the nature of the operations of the business. In 
a mercantile or industrial business the principal source of 
cash receipts is its sales. At the beginning of any budget 
period there will be certain accounts receivable outstanding 
from which funds will be received during the next budget 
period, and there will be additional accounts receivable re- 
sulting from the sales during the period from which col- 
lection will be derived during the period. In a retail store 
there will also be receipts from cash sales. 

The method to be employed in estimating the receipts 
from accounts receivable and sales depends on the number 
of customers and the terms on which they are sold. In a 
small business or in a business which has few customers, it 
is possible to take each customer and estimate the amount 
which will be obtained from the accounts receivable which 
he owes at the beginning of the budget period, and also the 
amount of the sales which will be made to him during the 
budget period and the collections which will be made during 
the period from the accounts receivable arising from these 
sales. In a large business which has many customers, 
this method is impracticable. In such a case the method 



302 BUDGETARY CONTROL 

to be followed will be determined largely by the terms on 
which the sales are made. 

In a retail department store a considerable part of the 
sales are for cash. ''The sales on account are due at the 
end of the month and presumably are paid during the first 
few days of the following month. In such a business it is 
necessary to estimate separately the cash sales and the 
sales on account. The records will show the ratio of cash 
sales and account sales to total sales during the past, and 
these ratios can be used in estimating the amount of the 
total estimated sales which will be made on each of these 
terms. The cash sales will result in cash receipts for the 
month in which they are made, while the sales on account 
will result in cash receipts during the following month. 
In the case of the account sales, allowance must be made 
for the bad debts and also for those accounts which will 
not prove bad but will not be paid promptly. The amount 
of both these accounts can be estimated on the basis of 
past experience. ' 

In some businesses sales are made on terms which re- 
sult in the payment for all the sales of each month on the 
same day. For instance, a customer is sent a statement 
at the end of each month for his purchases during the month 
and he pays on the fifteenth of the following month. In 
such cases it is not difficult to estimate when the cash re- 
ceipts from the sales will be obtained. 

If a business sells on terms of i/io, n/30; 1/20, n/30, 
etc., which result in the receipt of cash from accounts re- 
ceivable throughout the month, it is necessary to resort to 
ratios to estimate the cash receipts from estimated sales. 
A study of past records will show in many businesses that 
there is a fairly uniform ratio between sales and collections. 
This ratio may vary during different months or seasons of 
the year, and it may vary during different years owing to 



THE FINANCIAL BUDGET 303 

trade and market conditions. But by careful study it is 
often possible to obtain a ratio which is approximately 
correct. 

After the ratio of collections to sales for past periods is 
obtained, it is applied to the estimated sales for each 
month of the next period to determine the estimated cash 
receipts for each month. The inaccuracies which may arise 
from this method are apparent. It, of course, will be under- 
stood that it is never possible to obtain exact estimates of 
cash receipts or disbursements. We carry a cash balance 
primarily to provide for these inaccuracies. 

Because of the wide and unforeseen fluctuations in the 
volume of sales during the past eighteen months, some 
firms have found it impossible to use the ratio of sales to 
collections as a basis of estimating their cash receipts. 
Various other methods have been devised. One business 
has found that they receive no cash receipts during the 
month from sales made after the twentieth of the month. 
Accordingly they add the estimated sales for the first 
twenty days of the month to the accounts receivable out- 
standing at the beginning of the month, and use the sum 
as the basis of their estimate of cash receipts for the month. 
Experience has shown that they can expect to collect a 
fairly uniform percentage of this amount during the month. 

Estimate of Cash Receipts Based on Lag of Collections on Sales 

Another method of handling this problem is suggested 
by Mr. Morris A. Copeland in the December, 1920 issue 
of the Journal of Political Economy. At the author's re- 
quest, Mr. Copeland has submitted the following statement 
in explanation of this method : 

One method of handling the problem is to calculate the average 
turnover or collection period, and use this directly as a lag on sales. 
The average turnover period of accounts receivable in fractions of a 



304 



BUDGETARY CONTROL 



year is the average of accounts receivable at the end of each month 
divided by the amount of the collections for the year. In case this 
should prove to be one-twelfth, the sales estimate for March 
would be the collections estimate for April, etc. But if it were 
twenty days, instead of a month, the collections for May would be 



$200,000 



150.000 



100.000 



50,000 















/ 


/ 












^ 


/ 










4>/ 




___. 






>' 


/ 


75?__ 






/ 












/ 


/ / 


/ 















Figure 29. Graph Showing Accumulated 
Sales and Collections 



approximately equal to the sales from April 11 to May 11, a figure 
which cannot be obtained conveniently from the sales estimate if it 
states the sales by calendar months. 

Partly on this account and partly because the collections period 
may vary from season to season, and is sure to vary according to 
business conditions, the whole thing may be shown more easily 
graphically. It is evident that if the collections period varies, the 



THE FINANCIAL BUDGET 305 

collections for one month will not correspond to the sales during an 
interval of equal length. For a good mathematical reason which 
we need not go into here, it is best to show the sales and collection 
in cumulative form, i.e., to show the total sales from January i to 
each succeeding date. 

Figure 29 illustrates the graphical method. The dates are 
shown in the horizontal scale (Sundays and holidays should be 
omitted) ; the amounts are shown on the vertical. This diagram is 
based on the following data: 

Estimated 
Month Sales Estimate Collection 

Period 

December $50,000 20 days 

January 35,ooo 30 " 

February 25,000 28 " 

March 20,000 35 " 

April ' 25,000 30 " 

May 30,000 25 " 

June 30,000 20 " 

$215,000 

The estimated collection period is measured from the first of 
each month, and is the horizontal distance from the sales graph at 
that time to the collections graph. The collections graph is obtained 
by connecting the right-hand ends of these horizontal lines. From 
it we can read off the collections estimate for any month, as January 
$37,500 and May $32,500. 

Cash Receipts from Miscellaneous Sources 

After the estimate of collections from sales is made, it 
is necessary to determine whether cash may be received 
from any other source. In many cases interest is received 
on bank balances. If notes are taken from customers, 
these will often bear interest. If stock or bonds of other 
companies are owned by the company, the probable income 
from dividends or interest must be considered. If a com- 
pany maintains a restaurant for employees, cash receipts 
will result therefrom. If a company owns houses which it 
20 



306 BUDGETARY CONTROL 

rents to employees, the cash receipts to be received from 
these must be included. In some businesses there may be 
other sources of income. In any case, all these sources 
must be carefully considered and recorded in the estimate 
of cash receipts. It is not difficult to estimate the cash 
receipts from any of these sources. 

It may be well to add a word of caution to the effect 
that a careful distinction must be made between cash 
receipts and accrued income. For instance, interest on 
bonds owned may accrue in one period but not be paid 
until a subsequent period. On the other hand, interest 
may be received during one period which has accrued over 
several past periods. It will be seen, therefore, that the 
amount of interest and similar items recorded on the 
financial budget during any period will in all probability 
not agree with the amount of these same items as entered 
in the financial records. 

Estimating the Cash Receipts for Different Types of Business 

In a professional firm the principal source of cash re- 
ceipts is from the sale of services to clients, and an estimate 
of the cash receipts from this source can be made in a 
manner similar to that in which the estimate of receipts 
from the sale of commodities is determined in a mercantile 
firm. In this connection it must be remembered that an 
engagement may not be completed until a considerable 
time after it is sold, and if the engagement is not unduly 
long the client may not be invoiced until it is completed. 
It may also be worth mentioning that clients are often 
dilatory in paying for professional services. Usually there 
is no discount offered for prompt payment, nor even are 
specific terms stated on the invoices of professional firms. 
Consequently a firm is apt to postpone payment of the 
invoice for professional services and pay an invoice for 



THE FINANCIAL BUDGET 307 

merchandise on which a discount is offered. These factors 
must be considered in preparing the estimate of cash 
receipts of a professional firm. 

In a financial institution, such as a bank, the principal 
sources of cash receipts are entirely different from those of 
a mercantile or industrial firm, but the method of deter- 
mining the amount of these in the two cases is not greatly 
dissimilar. A bank derives its chief income from interest 
on loans, and the amount of the receipts from this source is 
not difficult to determine. The receipts from exchange, 
investments, etc., are not difficult to estimate. Care must 
be exercised here as in other businesses to distinguish care- 
fully between accrued income and cash receipts. 

In other types of businesses there are still other sources 
of cash receipts, but if the general principles developed in 
the foregoing discussion are kept in mind, it should not be 
difficult to develop a procedure for making an estimate of 
cash receipts for any type of business. 

Form of the Estimate of Cash Receipts 

In making up the estimate of cash receipts, a careful 
record should be made of the amount estimated to be re- 
ceived from each source. A form should be designed to 
show the estimated receipts for each month of the budget 
period as well as the total for the period. This enables the 
budget committee to judge better the financial program 
which is proposed, and enables the treasurer to see the cash 
available each month, so that he can plan his cash dis- 
bursements and loans. It also makes possible a check on 
the financial program at the end of each month, since 
the estimated receipts can be compared with the actual 
receipts. These comparisons are valuable both in con- 
trolling the present estimates and in the preparation of 
future ones. 



3o8 



BUDGETARY CONTROL 



A simple form of the estlmiate of cash receipts is shown 
in Figure 30. This form assumes a budget period of three 
months in length. If a longer period is used additional 
columns can be added. 



ESTIMATED CASH RECEIPTS 
For Quarter Ending March 31, 192__ 


SOURCE 


JANUARY 


FEBRUARY 


MARCH 


TOTAL 


Accounts Receivable: 
Customers-Class A 
Schedule No. 1 

Customers-Class B 
Schedule No. 2 - 

Customers-Class C 
Schedule No. 3 

Notes Receivable: 
Not Discounted 
Schedule No. 4 

Sales: 

Customers-Class A 
Schedule No. 5 

Customers-Class B 
Schedule No. 6 

Customers-Class C 
Schedule No. 7 

Miscellaneous: 

Income from Investments 
Interest on Bank Balances 






' 




Total 











Figure 30. Estimate of Cash Receipts 

Determination of Cash Disbursements 

It is necessary that an estimate of cash disbursements 
be prepared to be used in connection with the estimate of 
cash receipts in order to complete the financial budget. 
To do this it is necessary to prepare an estimate of the 
expenditures necessary to carry on the operations of every 
department of the business. A discussion of the various 
departmental estimates has been given in previous chapters, 



THE FINANCIAL BUDGET 309 

and the method of estimating the cash disbursements re- 
quired by each has been explained. 

A brief review of the discussion in the previous chapters 
will be given here to show the relation of these estimates to 
the estimate of cash disbursements. 

Disbursements for Purchases of Mercantile Store 

The principal disbursements of a mercantile business are 
for merchandise. The purchases budget, if prepared in 
the form explained in Chapters XIV and XV, will show the 
following information for each month of the budget period : 

1. Inventory at beginning of month. 

2. Estimated deliveries to stock during month. 

3. Estimated orders to be placed during month. 

4. Estimated inventory at end of month. 

5. Estimated cash disbursements for purchases made during pre- 

vious months. 

6. Estimated cash disbursements for purchases made during the 

month. 

Items (5) and (6) will be added for each month and entered 
in the estimate for cash disbursements. 

It is usually easier to estimate the disbursements for 
purchases than to estimate the receipts from sales. The 
purchases are made in large quantities and consequently 
there are fewer creditors than there are customers. A busi- 
ness controls the payment of its liabilities and knows 
whether it will take its discounts or wait until the end of 
the credit period. It does not control the receipts from 
customers and can judge what they will do only by what 
the past indicates. After the purchasing department knows 
the purchases which must be made to meet sales demands, 
it should not have any particular difficulty in preparing the 
purchases budget so that it will show the information stated 
above. 



310 



BUDGETARY CONTROL 



Disbursements for Production Purposes by Manufacturing 
Business 

The principal disbursements of a manufacturing business 
are for materials, labor, and manufacturing expenses. 
The method of estimating the amount of each of these and 
the form in which the estimate of each should be prepared, 
has been discussed in the chapters on the materials, labor, 
and manufacturing expense budgets. 

In estimating the disbursements for materials, a proce- 
dure similar to that followed in estimating the disburse- 
ments for the finished goods of a mercantile firm is necessary. 
First, the materials which are to be purchased must be 
determined, and then the date of payment for these pur- 
chases must be calculated. 

The disbursements for labor are ordinarily made dur- 
ing the same period in which the labor is consumed. If 
the estimate of disbursements is made on the basis of cal- 
endar months this may not be true, for labor may be paid 
on a weekly basis. In this case there is apt to be an accrued 
pay-roll at the end of the month which will need to be paid 
during the following month. Some firms use a four- week 
period instead of a calendar month as the basis for both 
their accounting and budgetary records. This procedure 
eliminates the difiiculty of accrued pay-roll but may give 
rise to accruals for expenses for which invoices are rendered 
on the basis of the calendar month. 

A large part of the manufacturing expense will con- 
sist of supplies which may be purchased in one period 
and paid for during the next period. Consequently, the 
disbursements for these must be determined in a manner 
similar to the disbursements for materials and finished 
goods. Indirect labor will also be included in the manu- 
facturing expense estimate, and will usually be paid for 
during the period in which it is consumed. The re- 



THE FINANCIAL BUDGET 



311 



ESTIMATED CASH DISBURSEMENTS 


For Quarter Ending March 31. 192 










PURPOSE 


January 


February 


March 


Total 


NOTES Payable 










ACCOUNTS Payable 

Outstanding, Jan. 1 
Estimated Cash Dis- 
bursements for 
Purchases 










Factory Payroll 

Department A 
Department B 
Department C 










FACTORY EXPENSE 

Department A 
Department B 
Department C 










Departmental Expense 
President's Office 
Treasurer's Department 
Auditor's Department 
Purchasing Department 
Office Manager's Department 
Traffic Department 
Sales Department 
Production Department 










NeWEquipment 










CORPORATE 

Taxes CNon-property) 
Attorneys' Fees 
Directors' Fees 
Miscellaneous 










TOTAL 




' 







Figure 31. Simple Estimate of Cash Disbursements 



312 



BUDGETARY CONTROL 



marks with reference to direct labor are equally applicable 
here. 

In a manufacturing business there will be disbursements 
for manufacturing plant and equipment, and in all busi- 
nesses there will be disbursements for furniture and office 
equipment. The preparation of the estimate for plant 
and equipment has been discussed in Chapters XVI and 
XVII. This estimate shows the plant and equipment 
desired and the date when needed. The purchasing agent 
will need to use this as a basis for estimating the date of 
payment for the equipment purchased. 

Disbursements for Expenses 

After the expenditures necessary to obtain the goods 
needed to supply the sales demands, and the disbursements 
necessary to secure the required amount of plant and equip- 
ment, are determined, it is necessary to estimate the dis- 
bursements which must be incurred in operating the busi- 
ness so as to secure the sales and deliver the goods to the 
customers. This requires the preparation of an estimate 
of selling expenses by the sales department, an estimate of 
executive expenses by the general office, an estimate of 
corporate expenses by the secretary or some other official 
designated by the president, and an estimate of auxiliary 
expenses by each of the service departments, such as the 
personnel department, purchasing department, etc. 

The content and form of the various expense estimates 
have been discussed in Chapter XVIII. 



Form of the Estimate of Cash Disbursements 

In making up the estimate of cash disbursements, a 
careful record should be made of the estimated amount to 
be disbursed for each purpose. A form should be designed 
to show the estimated disbursements for each month of the 



THE FINANCIAL BUDGET 313 

MONTHLY REPORT ON ESTIMATED CASH DISBURSEMENTS 
Month of December, 1921 

Estimated Disbursements at the General 
Office : 

General Office Pay-Roil $10,311 .45 

General Office Building Rental 3.541 .67 

Interest Payable on Notes 6,700.00 

Interest Payable on Bonds 50,000.00 

Dividends 25,000 . 00 

South X Real Estate Tax 48,800.00 

A State Tax 3,145.00 

Equipment (General Office) 210.00 

Other General Office Purchases, etc 6,425 .00 

Advertising , 6,41 1 . 00 

Eastern Division and X Works — Pay-Roll . ... 133,166.46 
Eastern Division and X Works — Purchases 

(except Pipe) 94,000 . 00 

X Branch Pay-Roil 10,500 .00 

Branch Pay-Rolls Paid from General Office 

except X Branch . . 4,998 . 34 

X Branch Purchases 14,500.00 

Consigned Pipe Purchases 68,350.00 

$486,058.92 

To Western Division 75,000 .00 

Estimated Disbursements at Western Divi- 
sion and Y Works 310,500 . 00 

Estimated Disbursements of Branches: 

A Branch $36,500 . 00 

B Branch 30,000 . 00 

C Branch 65 ,000 . 00 

D Branch 25,000.00 

156,500.00 

Estimated Disbursements of M Company 
OF Oregon: 

Outside Purchases and Pay-RoU $75,000.00 

To M Manufacturing Company 20,000.00 

95,000.00 

Estimated Disbursements of M Interna- 
tional Company: 

Outside Purchases and Pay-RoU $39,000.00 

To M Manufacturing Company 80,000.00 

119,000.00 

Total $1, 242,058. q2 



Figure 32. More Elaborate Estimate of Cash Disbursements 



314 



BUDGETARY CONTROL 



budget period as well as the total for the period. This 
enables the budget committee to judge better the financial 
program which is proposed and enables the treasurer to see 
the cash required each month, so that he can make plans 
to secure the necessary amount. It also makes possible 
a check on the financial program at the end of each month, 
since the estimated disbursements can be compared with 
the actual disbursements. These comparisons are valuable 
both in controlling the present estimates and in the prep- 
aration of future estimates. 

A simple form of the estimate of cash receipts is shown 
in Figure 31. This form assumes a budget period of three 
months in length. If a longer period is used, additional 
columns can be added. 



Estimating the Cash Disbursements for Different Types of 
Businesses 

In different types of businesses the method of estimating 
the cash disbursements will vary somewhat because of the 
different operations they perform, but the same general 
procedure will be followed in preparing the estimate of 
cash disbursements. 

In a professional firm the principal item of disbursements 
will be the salaries of the staff. The amount of these will 
be easy to obtain. In addition there will be the disburse- 
ments necessary for maintaining the office. These also 
can be estimated easily. 

In a financial institution, such as a bank, there will be 
three principal items of disbursements: (i) the interest paid 
on deposits, (2) the salaries of the employed staff, and (3) 
the office expenses. None of these are difficult to estimate. 
In estimating the cost of supplies used in the various offices 
the same problems arise as in the estimating of the disburse- 
ments for purchases of a mercantile or industrial firm. 



THE FINANCIAL BUDGET 315 

In other types of businesses there are still other purposes 
for which disbursements must be made, but if the general 
principles developed in the foregoing discussion are kept 
in mind, it should not be difficult to develop a procedure for 
making the estimate of cash disbursements for any of these. 

Various Items Appearing on Estimate of Cash Disbursements 

The estimate of cash disbursements shown in Figure 31 
is purposely made quite simple. In many businesses more 
numerous items would appear on this estimate. As an 
indication of some of the items which may appear on such 
an estimate. Figure 32 shows the estimate of cash disburse- 
ments of a large manufacturing firm for the month of 
December, 1921. 

The amounts have been changed since these are im- 
material for our purposes. This company has two fac- 
tories and seven branches. The classification of items 
shown on the estimate is not the most desirable, but is the 
one found most expedient by the company at its present 
stage of development in financial control. 



CHAPTER XX 
THE FINANCIAL BUDGET (Continued) 

Relation of Financial Budget to Bank Loans 

After the estimates of cash receipts and cash disburse- 
ments are completed, a statement can be prepared showing 
the relation of the estimated receipts to the estimated dis- 
bursements. If the disbursements exceed the receipts, the 
excess will usually be met by means of bank loans. If the 
receipts exceed the disbursements, the excess will usually 
be used in the reduction of bank loans contracted during 
previous periods when the disbursements exceeded the 
receipts. 

In determining the amount of the loans necessary, or 
vice versa, the cash balance at the beginning of the period 
and the desired cash balance at the end of the period must 
be taken into consideration. The amount of the cash 
balance may be determined by what the firm has learned 
by experience is a necessary minimum, or it may be deter- 
mined by the minimum requirements of the banks. Banks 
usually insist that the cash balance be maintained at a 
certain percentage of the loans obtained from them. 
Consequently, as the loans at a bank increase, the cash 
balance must increase accordingly. 

A simple form of statement which will provide the in- 
formation suggested in the preceding discussion is shown in 
Figure 33. 

In this illustration it is assumed that the disbursements 
are such that loans are required. If the opposite situation 
exists, the last item on the summary will read "Loans to 
be Liquidated," instead of ''Loans Required." 

316 



THE FINANCIAL BUDGET 



317 



Program for Bank Loans 

On the basis of the estimated cash receipts (Figure 30, 
page 308), the estimated cash disbursements (Figure 31, 
page 311), and the summary of financial requirements 
(Figure 33), it is possible to prepare a statement showing 
the program to be followed with reference to bank loans. 
The contents of such a statement is indicated by Figure 34. 

A statement made in this form is useful to the president 
and board of directors, since it shows them the effect of the 
contemplated program on the bank indebtedness. If they 



SUMMARY OF FINANCIAL REQUIREMENTS 
For Quarter Ending March 31, 192_ 




January 


February 


March 


Total 


Cash Balance at the 

Beginning of Month 
Receipts 

Total 
Disbursements 

Excess of Disbursements 
Cash Balance at End of 
Month 

Loans Required 











































Figure 33. Summary of Financial Requirements 

approve the program as suggested, they may authorize the 
treasurer to carry out its provisions. The treasurer, in 
addition to this program, will need a more detailed state- 
ment which will show him the exact dates on which addi- 
tional funds must be obtained, with the consequent renew- 
ing of notes, discounting of customers' notes, etc. 

Preparation of Financial Budget 

The various departmental estimates as sent to the exec- 
utive in charge of the budgetary procedure provide the 



3l8 BUDGETARY CONTROL 

data from which the estimates of cash receipts and cash 
disbursements are prepared. Some of these estimates 
provide information which can be transferred directly to 



SUGGESTED PROGRAM FOR BANK LOANS 
For Quarter Ending March 31, 1922 



Situation at Beginning of Quarter: 

Notes Payable $ 500,000 

Notes Receivable Discounted 780,000 



Total $1 ,280,000 

Monthly Program: 

January: 

Renew $45,000 of $47,500 due 

Reduction of Notes Payable for Month $ 2,500 

Notes Receivable Discounted Matured 300,000 

Total Reduction of Indebtedness to Bank $ 302,500 

February: 

Renew $75,000 of Notes falling due 

Notes Receivable Discounted Matured $ 290,000 

Total Reduction of Indebtedness to Bank $ 290,000 

March: 

Renew $60,000 of Notes falling due 

Discount Notes of R. L. S. and J. J. S. for $71,000 

Increase of Indebtedness $ 71,000 

Notes Receivable Discounted Matured 100,000 

Net Reduction for Month $ 29,000 

Situation at End of Quarter: 

Notes Payable $ 531,500 

Notes Receivable Discounted 90,000 

Total $ 621,500 



Figure 34. Financial Program for Bank Loans 

the cash estimates. For instance, the estimate of pur- 
chases, if prepared in the manner suggested in Chapter XV, 
will show the estimated disbursements for purchases for 
each month. Other estimates show only the volume of 



THE FINANCIAL BUDGET 319 

the Operations of the department for which they are made 
and an estimate must be prepared of the effect of these 
operations on the cash balance. The sales budget is an 
illustration of this type. It states the estimated sales 
for the budget period, but there is a lag between the sales 
and the collections therefrom, which necessitates that an 
estimate of collections must be prepared, based on the sales 
estimate. 

In some cases the cash estimates are prepared by the 
executive in charge of the budgetary procedure, while in 
other cases they are prepared by the treasurer. Probably 
the best plan is to have these officials cooperate in their 
preparation. The executive in charge of the budgetary 
procedure can easily obtain most of the items of disburse- 
ment directly from the departmental estimates. The 
treasurer will prepare an estimate of the disbursements of 
his department. He also usually prepares the estimate of 
collections, since he has available the data necessary for 
its preparation. In some cases he makes the estimate of 
disbursements for corporate expenses. 

In any case, after the cash estimates are completed 
they should be submitted to the treasurer for approval 
before they are transferred to the budget committee. The 
budget committee will consider these in connection with the 
various departmental estimates and make any revisions 
which it thinks necessary. After they are approved by 
the budget committee they will be transferred by the 
executive in charge of budgetary procedure to the depart- 
ments concerned. 

Control of Financial Budget 

After the departmental estimates have been approved 
by the budget committee, the departmental heads should 
not be permitted to exceed their estimates without the 



320 BUDGETARY CONTROL 

permission of the committee. At the end of each month a 
report should be made to the budget committee, showing 
a comparison between the estimated expenditures for each 
department for the budget period and the actual ex- 
penditures to date. This report enables the committee 
to see the tendency in each department and makes it 
possible for it to take measures to prevent undesirable 
tendencies. 

In the same manner a report should be made showing a 
comparison between the estimated and the actual collec- 
tions for the month, since collections are the principal 
source of cash receipts. This report will be more useful if 
it also shows comparisons between sales and collections. 
The contents of such a report are indicated by Figure 35. 
The percentages shown in this report, if obtained for a 
number of periods, will be useful in estimating receipts from 
collections for future periods. 

It is important to emphasize that if effective control is 
to be exercised over the financial budget, it is necessary to 
control carefully the disbursements and receipts of the 
separate departments, since, as previously explained, the 
financial budget is but a combination of the departmental 
budgets. 

Monthly reports should be made showing a comparison 
between the estimated receipts and the actual receipts from 
all sources and the estimated disbursements and the actual 
disbursements from all sources. These reports will be 
submitted to the budget committee together with the other 
budgetary reports. Simple forms for these monthly re- 
ports of receipts and disbursements are shown in Figures 
36 and 37. If revisions in the various departmental 
budgets are made on the basis of the monthly reports re- 
ceived by the budget committee, these revisions must be 
given effect in the cash budget. 



THE FINANCIAL BUDGET 



321 



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322 



BUDGETARY CONTROL 



Length of Cash Period 

Although the financial budget may be made for a quar- 
ter, a half, or a whole year, it is necessary to make a com- 
parison between the cash receipts and cash disbursements 
over shorter periods of time than is represented by the 
budget; otherwise there may be times during the period 



MONTHLY REPORT ON CASH RECEIPTS 



MONTH OF_ 



J9J 



SOURCE 



Amount 
Received 



Estimated 
Receipts 



Per Cent 
Increase 



Decrease 



Comments 



Figure 36. Monthly Cash Receipts Report 



when there will not be sufficient cash on hand to meet cur- 
rent obligations. For instance, the cash receipts from ac- 
counts receivable and miscellaneous sources from January i 
to April I may exceed the cash disbursements for the same 
period, but there may not be sufficient cash to meet cur- 
rent demands at one or more times during that period. 
The demand for cash is an imperative one and care must be 
exercised to see that it is forthcoming at the time needed. 



THE FINANCIAL BUDGET 



323 



In the preceding discussion it has been assumed that 
such comparisons will be made monthly. The estimated 
receipts for each month are compared with the estimated 
disbursements for the month, and the excess of disburse- 
ments which must be financed determined. Usually this 
procedure is satisfactory, but there may be cases where the 



MONTHLY REPORT ON CASH DISBURSEMENTS 

Month of 1Q9 




1 


PURPOSE 


Amount 
Disbursed 


Estimated 
Disbursement 


Per Cent 
Increase 
„ or 
Decrease 


COMMENTS 














Figure 37. Monthly Cash Disbursements Report 

receipts and disbursements fluctuate so violently that it Is 
necessary to have a comparison on the basis of ten- or 
fifteen-day periods. In such businesses the fluctuating 
demand for cash is usually satisfied by arranging a ''re- 
serve line" of credit at banks so that additional funds can 
be obtained immediately at any time when they are needed. 



324 BUDGETARY CONTROL 

Formulation of a Financial Program 

In the foregoing discussion the procedure by which the 
financial budget is prepared has been explained. It should 
be apparent that this procedure can be effective only when 
it is exercised as a part of a well-formulated financial pro- 
gram. It is not only necessary to know what the financial 
requirements of a business are, so that plans to meet them 
can be made, but it is also necessary to know that these 
requirements are what they should he. In other words, it is 
desirable to know whether the financial program called for 
by the financial budget is the one which will be the most 
profitable to the business. A consideration of what con- 
stitutes a proper financial program would necessitate a 
discussion of the whole program of financial management 
which is beyond the province of this discussion. 

There are one or two phases of the financial program, 
however, which are so vitally connected with the deter- 
mination of cash requirements that it is worth while to 
mention them here. 

Constant and Variable Capital Requirements 

Bankers have given considerable attention to the analy- 
sis of the assets and liabilities of business firms in connec- 
tion with the granting of loans. From the viewpoint of 
credit granting, they have found it desirable to differentiate 
between fixed assets and current assets, and between fixed 
liabilities and current liabilities. This distinction is made 
largely on the basis of turnover. An asset with a slow 
turnover is termed a "fixed" asset, while one with a rapid 
turnover is termed a "current" asset. Liabilities are 
classified in the same manner. Since bankers have em- 
phasized this classification in their relations with business 
men, the latter have come to regard it as fundamental. 
Many bankers have insisted on the use of the "rule-of- 



THE FINANCIAL BUDGET 325 

thumb" financial standard of the ''2 to i " ratio, and busi- 
ness men have come to beHeve that so long as they succeed 
in keeping their current assets twice their current liabilities, 
they are successful financial managers. 

The classification of assets and liabilities as current and 
fixed is very useful in many cases, but it sometimes leads to 
a confusion of thought. Because any particular piece of 
merchandise will presently be converted into cash again, 
it is felt that it is a less permanent form of investment than 
a building. From the viewpoint of credit this is true, but 
from the viewpoint of capital requirements it may not be so. 
If a concern never allows its merchandise inventory to fall 
below $20,000 that twenty thousand dollars is as truly a 
permanent investment in the business as is the cost of the 
longest-lived of its permanent assets. The same may be 
true of current liabilities. Many concerns never pay off all 
of their short-time loans at once. A business that always 
owes at least $50,000 on short-time loans, though it may 
clear up its account at each bank once a year, is obtaining 
that much permanent capital on commercial loans. 

From the viewpoint of financial administration, there is 
a distinct difference between permanent assets and assets 
which involve a permanent investment. During any partic- 
ular period of time a given asset or liability, whether per- 
manent or current, whether an accrued or a deferred item, 
may vary in amount. The proprietorship may also change. 
Of course the variations in different assets may not all be 
in the same direction at the same time, so that some will 
serve to offset others and the same is true of liabilities and 
proprietorship. 

For the purposes of financial requirements, what is of 
primary importance are the changes in the totals. Usually 
the total of each of these items fluctuates constantly. 
These fluctuations may be due to seasonal operations, in 



326 BUDGETARY CONTROL 

which case they are confined between certain maximum 
and minimum Hmits. Or they may be due to the expan- 
sion or contraction of the operations of the business, in 
whicli case there may be a constant increase or decrease for 
a certain period of time. Even here a minimum or maxi- 
mum will sooner or later be reached. In the case of a 
decrease a minimum will be reached below which the 
business cannot continue to operate. In the case of an 
increase or expansion of business, in time a state of diminish- 
ing returns will be reached beyond which it will be unprof- 
itable for the business to expand and consequently the 
assets of the business will cease to increase. 

The minimum total of assets of a business during the 
period under consideration, such as a year, may be termed 
the "constant" assets of that business, and the amount in 
excess of this minimum may be termed the "variable" 
assets. In analogous fashion, constant and variable lia- 
bilities and proprietorship may be defined. Thus, if the 
balance sheet of the King Manufacturing Company on 
June I, 192 1, shows: 

Assets $200,000 

Liabilities 120,000 

Proprietorship $80,000 



and the lowest value for the total assets during the year is 
$160,000, this will be the constant assets and also the con- 
stant liabilities and proprietorship. The variable assets 
will be $40,000 on June i, and this will be also the amount 
of the variable liabilities and proprietorship. The varia- 
tions in the proprietorship total taken by itself will not 
ordinarily be large. It will usually increase gradually 
through an accumulation of profits and then drop off at 
the time when dividends are paid. If the profits are left 



THE FINANCIAL BUDGET 327 

in the business, there will be a permanent increase in the 
proprietorship, and if losses are incurred there may be a 
decrease. Proprietorship may be increased by a sale of 
stock, but this occurs rarely in the life of any particular 
business. 

The assets of a business at all times are equal to the 
proprietorship plus the liabilities. Since the proprietorship 
in most businesses under normal conditions fluctuates but 
little, it follows that the fluctuations in the assets usually 
result in like fluctuations in the liabilities. In other words, 
the variable assets tend to be offset by the variable liabili- 
ties. To illustrate, by the foregoing example of the King 
Manufacturing Company, it is evident that if the pro- 
prietorship remains approximately at $80,000 throughout 
the year and the assets are reduced to $160,000 at the time 
of the ''slack season" of the year, then the liabilities at 
that time of the year will be reduced to $80,000. 

The relation between the variable assets and the varia- 
ble liabilities is significant in that it points out the relation 
between the financial budget and the financial condition of 
a firm as shown by its balance sheet. An illustration will 
make this clear. It may be assumed that the assets of the 
King Manufacturing Company reach the minimum amount 
of $160,000 on January i, and that they then gradually 
increase until they reach the maximum amount of $200,000 
on June i, after which they gradually decrease until the 
minimum is reached again on January i. The increase in 
assets between January i to June i will probably be shown 
in the main by an increase in accounts receivable and mer- 
chandise inventory. To carry the increase in these items 
the firm will in all probability increase its borrowings from 
banks, although some part of the increase in inventory 
may be offset by an increase in accounts due to trade 
creditors. 



328 BUDGETARY CONTROL 

In SO far as the increase in assets is offset by an increase 
in bank loans, the financial budget during this period will 
show an excess of disbursements over receipts, since it is to 
meet such an excess that bank loans are contracted. 

During the period from June i to January i , the accounts 
receivable and merchandise inventory will be decreasing 
and the bank loans will be decreasing likewise. During the 
same period the financial budget will show an excess of 
receipts over disbursements and with this excess the bank 
loans are paid. 

Relation of Financial Budget to the Business Cycle 

The variable assets, and consequently the variable 
liabilitiesj will increase during the busy season of a season- 
able business, and will increase for all businesses during the 
upward trend of the business cycle when the operations of 
a business are expanding. They will decrease during the 
dull season and during the downward trend of the business 
cycle. In the same manner the financial budget should 
normally show an increase of disbursements in proportion 
to receipts during the busy season or upward trend of the 
business cycle, and it should show the opposite condition 
during the dull season and the downward trend of the 
cycle. 

Because of the non-liquid condition of the variable 
assets, this "normal" condition may not exist during the 
downward trend of the business cycle. For instance, dur- 
ing the year 1921 many firms were ''hard pressed " for funds 
because their variable liabilities became due, and their 
variable assets were not converted. In other words, it was 
impossible to reduce their assets to the minimum when it 
became desirable to reduce their liabilities. This condition, 
however, does not offset the general principle that during 
the downward trend of the cycle the cash receipts from the 



THE FINANCIAL BUDGET 329 

Operations of the business should exceed the disbursements 
other than for bank loans and that this excess should be 
used in paying these loans. The condition during 1921 
merely indicates that because of inadequate planning ahead 
many businesses were in such a condition when the down- 
ward trend of the cycle came that they could not do what 
the conditions of the times demanded. 

Relation of Financial Budget to Estimated Financial Statements 

The primary purpose of the foregoing discussion with 
reference to variable assets and liabilities and the financial 
budget is to show the close relationship between this budget 
and the financial condition of the business as shown by its 
balance sheet. The budget sets forth the results of the 
contemplated operations of the business in terms of finan- 
cial requirements. To interpret this budget properly and 
to judge properly of its desirability, the executives should 
have before them an estimated balance sheet showing the 
anticipated financial condition at the end of the period for 
which the budget is made. 

But the purpose of the operations of a business is to 
secure a profit. A contemplated program of expansion or 
contraction, as shown by the financial budget and estimated 
balance sheet, is desirable only if it will produce profitable 
results. To determine whether this result will be achieved, 
it is necessary to have an estimated statement of profit and 
loss showing the anticipated results of the contemplated 
program in terms of profit and loss. 

The financial budget, the estimated statement of 
profit and loss, and the estimated balance sheet, are the 
three statements which show the goal towards which the 
contemplated operations of the business, as reflected in the 
departmental estimates, are leading. If these statements 
are properly made and properly correlated, a basis for 



330 BUDGETARY CONTROL 

sound and efficient management is laid. The latter two 
statements will be discussed in the following chapters. 

Difficult Problems in Preparing Financial Budget 

The preparation of the financial budget is not an easy 
matter. In most businesses, problems of considerable 
magnitude and difficulty are encountered. Some of these 
are inherent in the problem of financial control and some 
are the result of circumstances which exist in particular 
businesses owing to personnel or to the nature of the opera- 
tions of the business. The nature of these problems has 
been indicated to some extent in the previous discussion. 
In order that it may not be thought that these difficulties 
have been disregarded or minimized, it is desirable to sum- 
marize them here. They may be stated as follows: 

1. The financial budget is a budget covering all the activities of the 

business; therefore it requires the cooperation of all the 
departments of the business. Without this cooperation it 
is impossible to prepare an accurate budget or to enforce it 
after it is prepared. 

2. The cash receipts and the cash disbursements in many cases 

are separated from the activities whioh produce the receipts 
or cause the disbursements by a certain interval of time, and 
it is difhcult to estimate accurately the length of this interval. 
For instance, the collections from sales are not made until 
some time after the sales take place, and the payments for 
purchases are not made until some time after the purchases 
are contracted for. 

3. The planning of finances is in most cases in the hands of the 

principal executive of the company or of the treasurer who 
acts as his confidential assistant. The financial methods 
which these executives employ are regarded as highly con- 
fidential. Consequently there is little or no exchange of 
information between companies with reference to financial 
methods, and no standardized procedure has been developed. 
In undertaking, therefore, the introduction of scientific 



THE FINANCIAL BUDGET 33 1 

financial planning, each firm is dependent largely on its own 
experiences and resourcefulness. 
4. The executives in charge of the financial operations of a business 
are usually loath to delegate any duties with reference to them 
to others, and hesitate to commit their plans to a definite form 
for fear that they will be hampered in their freedom of action 
and that important information may be divulged. 

None of these dif^culties is insurmountable, and for- 
tunately the present tendency indicates a rapid removal of 
the latter two and the development of scientific methods 
of overcoming the first two. 

Summary 

In the preceding pages an attempt has been made to 
outline the procedure necessary for the preparation and 
control of the financial budget. In summary form this 
procedure may be stated as follows: 

1 . Preparation of a Preliminary Estimate of Cash 
Receipts. This requires the determination of the proba- 
ble receipts from all sources. The principal source of cash 
receipts is the collections from accounts receivable, and 
the estimate of collections must be based on the estimate 
of sales which has been prepared in the manner previously 
explained. 

2. Preparation of a Preliminary Estimate of Cash 
Disbursements. This requires the determination of prob- 
able disbursements needed to finance the operations of all 
the departments of the business. Consequently the esti- 
mate of disbursements must be based on the various de- 
partmental estimates which have been explained in previous 
chapters. 

3. Preparation of the Cash Budget. The prelimi- 
nary estimates of cash receipts and disbursements explained 
in (i) and (2) are submitted, together with all the other 



332 BUDGETARY CONTROL 

estimates, to the budget committee. After the various 
departmental estimates have been approved, the pre- 
Hminary estimates of cash receipts and disbursements will 
be revised, if necessary, to give effect to any changes made 
in the departmental estimates by the budget committee. 
After the revised cash estimates are approved, they con- 
stitute a cash budget. 

4. Preparation of the Financial Program. Based 
on the preliminary estimates of cash receipts and disburse- 
ments, there will be prepared a suggested financial program 
which will indicate the financial procedure by which the 
requirements of the proposed financial program are to be 
met. This program will be revised, if necessary, to corre- 
spond to the revised financial budget and will then con- 
stitute the working program of the financial department. 

5. Preparation of an Estimated Balance Sheet 
AND Estimated Statement of Profit and Loss. These 
financial statements, discussed in the chapters immediately 
following, are studied in connection with the financial budg- 
et to determine the effect of the contemplated financial 
program on the financial condition and income of the busi- 
ness. 



CHAPTER XXI 
THE ESTIMATED BALANCE SHEET 

The Need for Financial Statements 

Business management can be exercised in a rational 
manner only when it is based on accurate and comprehen- 
sive information with reference to the operations of the busi- 
ness which is to be administered. Not only must informa- 
tion be available, but it should be in the form in which it 
will be the most serviceable to the business manager. A 
large part of the information used by the business executive 
is in the form of statistical data, and experience has shown 
that these data are most useful when presented by means of 
reports which show them in a summarized and classified 
form. Consequently, business men have long been accus- 
tomed to using statistical reports. 

The nature of these reports has been determined largely 
by necessity. When the executive has found that he must 
have certain information to carry on some activity which 
it has been necessary to perform, he has devised, or has had 
devised, a report which will provide him with this informa- 
tion. The balance sheet and the statement of profit and 
loss are the two reports with which the executive is most 
familiar and which are most widely used. The reason for 
the extensive use of these reports is not difficult to see if the 
development of accounting records and reports is considered. 

Balance Sheet 

Every business finds it necessary in the course of its de- 
velopment to borrow funds from banks and to purchase 
merchandise on account. In the not distant past both 
bank and merchandise creditors often granted credit on the 

333 



334 BUDGETARY CONTROL 

basis of the general reputation of the appHcant and the in- 
formation which they could obtain from him in an informal 
manner. During recent years, however, they have found 
it necessary to have more exact information and, to obtain 
this, have required a formal report showing the financial 
condition of the business. Consequently, the standard 
form of balance sheet has been developed for their use. The 
executive, being required to prepare this report for his 
creditors, gradually learned to make some use of it himself. 

Statement of Profit and Loss 

For many years creditors satisfied themselves with the 
information obtained from the balance sheet, but recently 
they have found it expedient to ask for additional informa- 
tion which will show the nature of the operations of the busi- 
ness and the result of these operations. They have found 
it desirable to have this information because they realize 
that, though the balance sheet shows the financial condition 
of the business at the time credit is requested, what the cred- 
itor is primarily interested in is its financial condition at the 
end of the period of credit. For instance, if a bank grants a 
loan for three months, it desires to know that the business 
will be able to pay the loan at maturity ; hence it is interested 
to know its financial condition three months from now. 

If it knows its present financial condition and the result 
of its past operations, it can estimate roughly the effect of 
its future operations on its present condition and arrive at 
an estimate of its financial condition three months in the 
future. The standard form of the statement of profit and 
loss has been designed to present to creditors and others the 
information with reference to the past operations of the 
business which they desire. Since the executive must pre- 
pare it for the use of others, he has learned, as in the case of 
the balance sheet, to use it for his own purposes. 



ESTIMATED BALANCE SHEET 335 

Standard Forms of Financial Statements 

The balance sheet and the statement of profit and loss 
have become, therefore, the two standard reports which are 
usually prepared by all businesses and which are used by 
the creditors, stockholders, and executives of the business 
in the making of decisions and the formulation of policies 
with reference to the business. Through the influence of 
national associations, such as the American Bankers' Asso- 
ciation and the National Association of Credit Men, as well 
as the writings and teachings of accountants, more or less 
standard forms for these statements have been developed. 
It is assumed that the form and content of these widely 
used and orthodox statements are familiar to the reader. 

Use of the Financial Reports 

The standard form of balance sheet and the standard 
form of statement of profit and loss show respectively the 
present financial condition of a business and the results in 
terms of profit and loss of its operations over a certain period 
of time. This information serves two purposes: 

1. It indicates the efficiency with which the business has been man- 

aged during the past, and 

2. It indicates the possible result of its future operations. 

The second purpose of the information provided by the 
financial reports has not been emphasized by writers and 
practitioners, and yet a little thought will show that it is the 
primary purpose for which this information is desired. It is 
true that these reports are usually discussed in terms of past 
results, but the principal purpose of studying past results is 
to be able better to control future results. Just as the credi- 
tor desires a statement of profit and loss, so that he can esti- 
mate the changes in' financial condition which will probably 
take place as a result of the future operations for a certain 



336 BUDGETARY CONTROL 

period of time — in the same manner the executive Is prima- 
rily interested in both the balance sheet and statement of 
profit and loss in order that he may be able to judge whether 
future operations will result in favorable changes in the 
financial condition of the business. 

It is true that both the creditor and the executive make 
their estimates informally and incompletely. Neither one 
may be conscious that he is making such an estimate at all. 
His thought raay proceed no farther than to reason that the 
operations for the past period have resulted in a profit and a 
favorable financial condition, and if the same policies are 
followed during the next period, equally favorable results 
will follow. If the results of the past period are undesirable, 
he may try to locate the cause and determine some means to 
remove it. If he succeeds in making changes which he 
thinks will remove the difftculties of the past period, he may 
assume that the results of the next period will be more satis- 
factory without working out in detail what these results 
will be. 

For instance, the executive may find that his small profits 
for the year are due to increased production cost, and that 
the increased cost is the result of wasteful and inefficient 
methods of handling materials and supplies in certain depart- 
ments of the factory. He changes the methods of these 
departments so as to lower the cost of materials and supplies, 
and assumes that as a result he will have a satisfactory profit 
without determining just what the change in profits will be. 
If he finds that the small profits are due to decreased sales, 
and the decreased sales are due to the failure of salesmen in 
specific territories, he may replace these salesmen with 
those who are thought to be efhcient and estimate that as a 
result of these changes favorable profits will be made. 

In both of these cases the executive may carry his think- 
ing a step farther. He may estimate the reduction in cost 



ESTIMATED BALANCE SHEET 337 

of materials which will be effected by the new methods, and 
then calculate what the profits of the business will be for the 
next fiscal period if the other results of operation are the 
same as for the past period. In the same manner he may 
estimate the increased sales which will be secured from the 
changes in sales personnel and the consequent results in 
profits. If he makes a number of changes and estimates 
the results of each of these, he is led to make a more or less 
detailed estimate of the result of future operations. 

Need for Estimated Financial Statements 

The foregoing discussion and illustrations should be suffi- 
cient to show that the standard forms of balance sheet and 
statement of profit and loss are used as a basis of planning 
future operations and estimating the results of these opera- 
tions. It should also be apparent that these plans and 
estimates are usually made in a very informal manner, 
and consequently are apt to be incomplete and inac- 
curate. In fact, they are little more than "expert guess- 
work." 

In the discussion of the various departmental budgets, 
it has been emphasized that if estimates are to be made 
they will be most serviceable if they are prepared in a 
systematic, complete, and formal manner. In pursuance 
of this policy, it is desirable that there be prepared an 
estimated balance sheet or "budget" of assets, liabilities, 
and proprietorship, and an estimated statement of profit 
and loss, or "budget" of income and expense, in the same 
manner that there is prepared a budget of sales, purchases, 
expenses, etc. 

It is the purpose of the present chapter to discuss the 
construction and use of the estimated balance sheet. The 
estimated statement of profit and loss will be discussed in 
the chapter immediately following. 

22 



338 BUDGETARY CONTROL 

Relation of the Departmental Estimates to the Estimated Finan- 
cial Reports 

The departmental estimates show the contemplated 
operations of the several departments. The profits of the 
company and its financial condition are dependent on these 
operations. After the departmental estimates are prepared , 
it is then necessary to prepare a preliminary estimated 
balance sheet showing the effect of the contemplated pro- 
gram on the financial condition of the business, and a pre- 
liminary estimated statement of profit and loss showing the 
result of the program in terms of profit and loss. 

By studying these two statements and comparing them 
with the statements at the beginning of the period, it is 
possible to judge the desirability of the proposed program. 
If the execution of the proposed program will lead to undesir- 
able results, it will be necessary to revise the departmental 
estimates. After these revisions are made, the preliminary 
estimated financial reports should be revised, to give effect 
to the changes in the departmental budgets. Although the 
budget period may be three, six, or twelve months in length, 
it is desirable that the estimated balance sheet and state- 
ment of profit and loss be made so as to show the anticipated 
results at the end of each month. Monthly comparisons 
can be made, then, between the estimated and the actual 
results. 

In the following discussion the method by which the 
estimated financial reports are made will first be considered, 
and then the method by which they are studied to see if they 
show the necessity of a revision in the departmental budgets 
will be explained. 

The Estimated Balance Sheet 

To make the discussion of the preparation of the esti- 
mated balance sheet more concrete, a simple balance sheet 



ESTIMATED BALANCE SHEET 339 

NATIONAL MANUFACTURING COMPANY 
BALANCE SHEET 
December 31, 1921 

Current Assets: 

Cash $ 48,000 

Notes Receivable 80,000 

Accounts Receivable $200,000 

Less: Reserve for Bad Debts 4,000 

196,000 



Inventory: 

Raw Materials $ 40,000 

Goods in Process 120,000 

Finished Goods 560,000 



720,000 

Accrued Items , . . . 500 

Total Current Assets $1,044,500 

Fixed Assets: 

Office Equipment $ 40,000 

Less: Reserve for Depreciation ... . 8,000 

$ 32,000 

160,000 



Machinery and Equipment $200,000 

Less: Reserve for Depreciation .... 40,000 



Buildings $160,000 

Less: Reserve for Depreciation .... 48,000 



112,000 

Land 240,000 

Total Fixed Assets — • 544,000 

Deferred Charges to Expense 27,000 

Good-Will 80,000 



Total Assets $1 ,695,500 

Current Liabilities: 

Notes Payable $ 100,000 

Accounts Payable 150,000 

Accrued Liabilities 10,000 



Total Current Liabilities $ 260,000 

Fixed Liabilities: 

Mortgages Payable $ 80,000 

Bonds Payable 80,000 



Total Fixed Liabilities 160,000 

Proprietorship: 

Capital Stock Outstanding $1,000,000 

Surplus 275,500 



Total Proprietorship 1,275,500 

Total Liabilities and Proprietorship $i,6q5.500 

Figure 38. Balance Sheet 



340 BUDGETARY CONTROL 

showing the financial condition of a business at the begin- 
ning of a fiscal period will be given, and on the basis of as- 
sumed departmental budgets an estimated balance sheet, as 
of the end of the period, will be prepared. For the sake of 
simplicity a budget period one year in length will be assumed, 
and only the estimated balance sheet at the end of the year 
will be given. The reader will understand that an estimated 
balance sheet at the end of each month is desirable. 

The balance sheet of the National Manufacturing Com- 
pany as of December 31, 1921, is shown in Figure 38. 

To show the preparation of the estimated balance sheet 
as of December 31, 1921, it will be necessary to take each 
item which appears on the balance sheet at the beginning of 
the period and see the method by which the changes which 
will occur in it are determined. 

Cash 

The cash which it is estimated will be received from the 
operations of the business during the budget period, will be 
shown by the estimate of cash receipts (Figure 30, page 308) 
which is prepared as part of the financial budget. The esti- 
mate of cash receipts does not show the cash to be received 
from bank loans, for the purpose of the estimate of cash re- 
ceipts and disbursements is to show the loans required. The 
amount of these loans can be determined from the financial 
program (Figure 34, page 318), which is prepared on the 
basis of the financial budget. The estimate of cash receipts 
also does not show the cash which may be received from new 
financing such as the sale of stock or bonds. The amount 
of such cash must be obtained by a consideration of the 
plans of the directors. 

The estimated disbursements for operating purposes 
can be obtained from the estimate of cash disbursements 
(Figure 3 1 , page 311). The estimate of cash disbursements 



ESTIMATED BALANCE SHEET 34I 

does not show the disbursements for paying bonds or retir- 
ing long-term notes. Such disbursements can be easily de- 
termined from the plans of the directors and the terms under 
which the bonds or notes were issued. 

After the estimated cash receipts from all sources and the 
estimated cash disbursements for all purposes are deter- 
mined, the estimated cash balance can be determined. 
Although this is the method by which the estimated cash 
balance is finally obtained, it is customary to decide what 
cash balance is deemed necessary and use this in preparing 
the summary of financial requirements (Figure 34, page 318) , 
from which the bank loans required are determined. Of 
course, if the bank loans required as shown by the prelimi- 
nary summary of financial requirements are larger than it is 
thought desirable or possible to obtain, revisions are neces- 
sary, and in making these revisions the estimated cash bal- 
ance may be cut down. 

Based on the financial budget of the National Manufac- 
turing Company, it is estimated that its cash balance on 
December 31, 1922, will be $20,000. 

Notes Receivable 

To determine the amount of the notes receivable which 
will be on hand at the end of the period, it is necessary to 
consider the following: 

(a) Notes receivable on hand at the beginning of the period. 

(b) Estimated notes receivable which will be received in payment of 

goods sold during the period. 

(c) Estimated notes receivable which will be received in payment of 

accounts during the period. 

(d) Estimated cash receipts from notes receivable during the period. 

It should be apparent to the reader that a+b+c — d 
equals the notes receivable on hand at the end of the period. 
If a business has but a few customers, it will be possible to 



342 BUDGETARY CONTROL 

determine the amount of b, c, and d by considering each 
customer separately. If there are numerous customers, it 
may be necessary to obtain the ratio between accounts re- 
ceivable and notes receivable for the past several years, and 
assume that this ratio will continue during the current year 
if no changes in terms or of general business conditions are 
anticipated. If new lines are to be introduced, which are to 
be sold on different terms, or if business conditions are such 
that clients are apt to give notes in payment of accounts in 
greater quantities than usual, these facts must be considered, 
and the estimated ratio between notes receivable and ac- 
counts receivable revised accordingly. After this ratio is 
determined, it will be applied to the estimated balance of 
unpaid claims against customers at the end of the period to 
obtain the estimated notes receivable outstanding. 

The National Manufacturing Company sells several 
classes of products. Some of these are sold on account, and 
some are sold on terms which provide for the receipt of trade 
acceptances and notes in payment. The tendency for the 
past three years has been for an increase of the sales of the 
latter in proportion to the former. The sales program for 
the year 1922 calls for an increase in this tendency during 
the next year. It is also anticipated that general business 
conditions are such that more than the usual number of 
notes will be received from customers in settlement of due 
accounts. It is estimated that under these conditions the 
notes receivable on hand on December 31, 1922, will amount 
to $120,000. 

Accounts Receivable 

The amount of the accounts receivable at the end of the 
budget period is estimated in a manner very similar to that 
employed in determining the amount of the notes receivable 
as explained in the preceding paragraph. It is necessary to 



ESTIMATED BALANCE SHEET 343 

consider (a) the balance outstanding at the beginning of the 
period ; (b) the accounts receivable resulting from the sales 
during the period ; (c) cash receipts from accounts receivable 
during the period. It is apparent that a+b — c is equal to 
the accounts receivable at the end of the period. 

On this basis it is estimated that the accounts receivable 
of the National Manufacturing Company on December 31, 
1922, will be $180,000. 

Reserve for Bad Debts 

The reserve for bad debts at the beginning of the period 
is 2 per cent of the accounts receivable, and it is estimated 
that the same ratio will exist at the end of the year. Con- 
sequently it is estimated that the reserve will be $3,600. 

Inventories 

The inventory of raw materials at the end of the period 
can be obtained from the materials budget, since this budget 
shows not only the deliveries to stock for each month, but 
also the balance on hand at the end of each month. The 
inventory of goods in process can be determined by a con- 
sideration of the following: (a) inventory at beginning of 
period ; (b) cost of the materials, labor, and manufacturing 
expense put into process during the period ; (c) finished goods 
transferred from factory to stock during the period. The 
inventory of goods in process at the end of the period is J 
equal to a+b — c. The items in (2) will be obtained from '^ 
the estimate of raw material requirements, the labor budget, 
and the manufacturing expense budget. Item (c) will be 
obtained from the finished goods budget. 

The inventory of finished goods can be obtained by a 
consideration of the following: (a) inventory at the begin- 
ning of the period; (b) finished goods transferred from fac- 
tory to stock during the period; (c) stock §old during the 



344 BUDGETARY CONTROL 

period. The inventory of finished goods at the end of the 
period is equal to a+b — c. Usually, in making up the esti- 
mate of finished goods required, the inventory desired of 
each separate item at the end of the period is estimated, 
since this inventory constitutes a part of the requirements 
for the period. If the inventory of the separate items 
which it is planned to have is extended at cost price, the total 
inventory can be obtained. In some cases it may be easier 
to reduce the sales estimate by the amount of the average 
gross profit and substitute the result in the equation given 
above. Either method may be followed and approximate 
accuracy obtained. 

On the basis of the present inventories and the various 
budgets, it is estimated that the inventories of the company 
on December 31, 1922, will be as follows: 

Raw materials $ 70,000 

Goods in Process 230,000 

Finished Goods 1,100,000 

Total $1 ,400,000 

Accrued Income 

The chief source of accrued income is accrued interest 
on notes receivable. The estimated increase in the amount 
of the notes will cause a corresponding increase in the 
amount of this item. Accordingly it is estimated to be 
$1,000 on December 31, 1922. 

Fixed Assets 

The plant and equipment budget shows the following 
for each class of fixed assets : (a) balance of asset and reserve 
for depreciation accounts at the beginning of the period; 

(b) estimated cost of assets to be acquired during the period ; 

(c) estimated depreciation for the period on both old and 
new assets; (d) balance of asset and depreciation accounts 



ESTIMATED BALANCE SHEET 345 

at the end of the period. It is very easy, therefore, to obtain 
from the plant and equipment budget the desired informa- 
tion for the estimated balance sheet with reference to both 
the fixed assets and the depreciation thereon. 

From the plant and equipment budget it is estimated 
that the fixed assets and reserves for depreciation of the 
company on December 31, 1922, will be as follows: 

Office Equipment $ 60,000 

Less: Reserve for Depreciation 14,000 

I 46,000 

Machinery and Equipment $280,000 

Less: Reserve for Depreciation 100,000 

180,000 

Building $200,000 

Less: Reserve for Depreciation 58,000 

142,000 

Land 240,000 

Total Fixed Assets $608,000 



Deferred Charges to Expense 

The deferred charges to expense consist of organization 
expenses, unexpired insurance, and prepaid interest. The 
organization expenses disappear from the balance sheet, 
since this is the last year of the period over which they are 
being allocated. The unexpired insurance can be deter- 
mined by a consideration of (a) the insurance which it is 
planned to place during the year, and (b) the insurance un- 
expired at the beginning of the year. The latter can be 
obtained from the insurance policy record, while the former 
must be obtained from the estimate on insurance. Usually 
there is one ofhcer who is responsible for all insurance con- 
tracts. In many cases this responsibility is placed on the 
treasurer. The responsible official will prepare an estimate 
of the contracts to be made and their length of life. The 
prepaid interest will arise largely from the notes of custom- 



346 BUDGETARY CONTROL 

ers which are discounted. The amount of the notes to be 
discounted can be determined from the financial program, 
which is prepared in connection with the financial budget. 

It is estimated that the deferred charges of the company 
on December 31, 1922, will be $35,000. 

Good-Will 

The book value of the good-will will not change during 
the year. 

Notes Payable 

The amount of the notes payable at the end of the year 
will depend on the following : (a) notes payable at beginning 
of the period ; (b) notes issued in payment of merchandise ; 
(c) notes issued in payment of accounts ; (d) notes issued to 
bank for loans; (e) notes paid during the period. The 
notes outstanding at the end of the period equal a+b4-c+ 
d — e. The notes to be issued to merchandise creditors in 
payment for merchandise can be determined by a consid- 
eration of the materials budget. This budget shows the 
purchases to be made during the period, classified under at 
least major groups or classes. Usually it is for only certain 
classes of merchandise that notes are given or trade accept- 
ances issued, and the amount of these classes of merchan- 
dise which is to be purchased can be obtained from the ma- 
terials budget. 

If notes or trade acceptances are issued for part of the 
purchases in different lines, it is then necessary to obtain 
the ratio between the purchases made for notes and the total 
purchases during past periods, and apply this percentage 
to the estimated purchases for the current period. In most 
businesses few, if any, notes are issued in payment of ac- 
counts. If such notes are issued, it is necessary to obtain 
the ratio between them and the total purchases on account, 



ESTIMATED BALANCE SHEET 347 

and apply this ratio to the estimated purchases on account 
for the current period. 

The amount of the notes to be issued to banks can be 
obtained from the financial program (page 318), prepared 
in connection with the financial budget. The disbursements 
made in the payment of notes payable are shown in the 
financial program and in the estimate of cash disbursements. 
In addition to the notes discussed above, notes payable 
may be issued to officers, employees, and friends of a com- 
pany. A separate estimate must be made of their amount. 
On the balance sheet it is desirable to state the notes issued 
for separate purposes and to different parties as separate 
items. For the sake of brevity they will be stated as one 
item in the present case. 

The notes payable of the company as of December 31, 
1922, will be $450,000, according to the estimate. 

Accounts Payable 

The amount of the accounts payable at the end of the 
period will be determined from the following: (a) accounts 
payable at the beginning of the period ; (b) purchases on ac- 
count during the period; (c) payments made on account 
during the period. The accounts payable at the end of 
the period equal a + b — c. The amount of the purchases 
on account will be obtained from the materials budget. 
The amount of the payments on account will be obtained 
from the estimate of cash disbursements. 

The accounts payable of the company as of December 
31, 1922, are estimated to be $200,000. 

Accrued Liabilities 

The principal items of accrued liabilities are accrued 
interest on notes payable and accrued wages. Since the 
company is planning to increase greatly the amount of its 



348 BUDGETARY CONTROL 

notes payable, this will result in an increase in the accrued 
interest. Since it also plans to increase very much its in- 
ventory of finished goods, this will result in an increase in 
production, with an enlarged labor force, which in turn 
will probably result in a larger item of accrued wages. It 
is estimated that the accrued wages and accrued interest 
on December 31, 1922, will amount to $20,000. 

Mortgages and Bonds Payable 

The anticipated increase in fixed assets will necessitate 
additional capital, and the treasurer recommends to the 
board of directors that the mortgages on real estate be in- 
creased by $40,000, and that $60,000 additional bonds be 
issued. Accordingly the fixed liabilities of the company on 
December 31, 1922, will be as follows: mortgages payable 
$120,000, bonds payable $140,000. 

Capital Stock 

The enlarged operations which are planned for the year 
will necessitate the procurement of additional capital. The 
president and the treasurer recommend to the board of di- 
rectors that $250,000 of additional stock be sold. The esti- 
mated capital stock of the company on December 31, 1922, 
therefore, will be $1,250,000. 

Surplus 

The amount of the surplus at the end of the period will 
be determined from the following: (a) surplus at the begin- 
ning of the period; (b) profits for the period; (c) dividends 
to be declared. The surplus at the end of that period will 
equal a + b — c. The profits for the period are determined 
from the estimated statement of profit and loss. The 
dividends to be paid will be determined by the board of 
directors. Taking these factors into consideration it is esti- 



ESTIMATED BALANCE SHEET 349 

mated that the surplus of the company on December 31, 
1922, will be $170,000. 

Interpretation of Estimated Balance Sheet 

On the basis of the information given in the preceding 
paragraphs, it is possible to construct a preliminary esti- 
mated balance sheet for the National Manufacturing Com- 
pany as of December 31, 1922. The contents of this report 
is shown in Figure 39. 

As previously explained, the purpose of the preliminary 
estimated balance sheet is to show the effect on the financial 
condition of the business of the proposed plans for the next 
period, as expressed in the departmental budgets. After it 
is prepared, it is necessary to study it to see whether it 
shows a desirable tendency, and, if it does not, revisions in 
the budgets should be made, if possible, so as to remedy the 
undesirable tendency. The easiest way to see the effect of 
the proposed budgets is to show the estimated balance sheet 
as of the end of the period in comparison with the actual bal- 
ance sheet at the beginning of the period. This comparison 
for the National Manufacturing Company is shown in 
Figure 39. 

The most significant comparisons shown by Figure 39 
will be considered. 

Cash 

It is estimated that the cash balance at the end of the 
year will be but slightly more than 40 per cent of the cash 
balance at the beginning of the year. A decrease in the 
cash balance is not in itself undesirable. In some cases it 
may be desirable, for the cash balance at the beginning of 
the period may have been too large. The important ques- 
tion to determine is whether the cash balance at the end of 
the year is sufficient. Although this question cannot be 



350 BUDGETARY CONTROL 

answered definitely, since there are no definite standards by 
which to judge the cash balance which a business should 
have, there are indications that the estimated balance for 
the company is too small. 

In the first place the current liabilities are $760,000, and 
it is safe to assume that these are maturing each day. The 
current assets are also presumably being converted into 
cash every day, but it is not difficult to conceive of a situa- 
tion where the liabilities maturing on a particular day may 
be more than the funds received from current assets on that 
day, plus a cash balance of $20,000. Then, of course, it is 
impossible, or at least impractical, to pay out the total 
cash balance. The primary purpose of the cash balance is 
to take up the possible slack between cash receipts and cash 
disbursements, and it is unwise to reduce this balance to too 
small an amount, especially if, as in this case, the excess of 
current assets over current liabilities is not large. 

A more important indication of the inadequacy of the 
estimated cash balance is the ratio between the cash balance 
and the notes payable. The latter item is not analyzed, but 
it is safe to assume that it is expected that a considerable part 
of the notes outstanding on December 31, 1922, will be in 
the hands of the bankers of the firm. Practically all banks 
require that a customer maintain a bank balance which 
bears a certain ratio to the loans made to the customer by 
the bank. Many banks require that the balance shall be 
20 per cent of the loans granted to the customer. If such a 
cash balance is required by the bankers of this company, 
its maximum bank loans on December 31, 1922, would be 
$100,000. It is hardly to be conceived that less than one- 
fifth of the notes issued by the firm are to bankers. 

It is probable that the estimated balance sheet calls for 
an impossible condition by planning for larger bank loans 
than the cash balance will make possible. In any case a 



ESTIMATED BALANCE SHEET 



351 



COMPARATIVE BALANCE SHEET 












for the 










NATIONAL MANUFACTURING COMPANY 










ASSETS 










Current Assets: 




1921 






1922 




Cash 

Notes Receivable 


$ 

$200,000 
4,000 

$ 40,000 
120,000 
560,000 


48,000 
80,000 

196,000 
720,000 


$ 

$ 

1 


$ 

180,000 
3,600 


20,000 
120,000 

176,400 
,400,000 




Accounts Receivable 


Less: Reserve for Bad Debts . 

Inventories: 
Raw Materials 


70,000 
230,000 
,100,000 1 


Goods in Process 

Finished Goods 


Accrued Items 




2,000 

$1,046,000 






1.000 


$1,717,400 


Total Current Assets 




Fixed Assets: 














Office Equipment 


$ 40,000 
8,000 $ 

$200,000 
40,000 


32,000 
160,000 
112,000 


$ 
$ 
$ 


60,000 
14,000 $ 


46,000 
180,000 
142,000 




Less: Depreciation 

Machinery and Equipment 

Less: Depreciation 

Building 


280,000 
100,000 

200,000 
58,000 


$160,000 
48,000 


Land 

Total Fixed Assets 




240,000 




- 


240,000 


608,000 


544,000 




Deperhed Charges to Expense. . 




24,000 








35,000 


Good-Will , 

Total Assets ^ 


LI 


80,000 
$1,694,000 








80.000 


$2,440,400 


ABILITIES 




Current Liabilities: 














Notes Payable 


$ 


100,000 

150,000 

10,000 

$ 260,000 




$ 


540,000 

200,000 

20,400 


$ 760,400 


Accounts Payable 

Accrued Liabihties 


Total Current Liabilities. . . 




Fixed Lubilities: 














Mortgages Payable 

Bonds Payable 

Total Fixed Liabilities 


$ 


80,000 
80,000 

160,000 




$ 


120,000 
140,000 


260,000 




Proprietorship : 














Capital Stock Outstanding 

Surplus 


$1,000,000 
274,000 




$1,250,000 
170,000 




Total Liabilities and Pro- 
prietorship 

Total Liabilities 




1,274,000 
$1,694,000 








1,420,000 


$2,440,400 







Figure 39. Comparative Balance Sheet, with Preliminary Estimate 



352 BUDGETARY CONTROL 

business doing the volume of business which this balance 
sheet indicates, should not at any time be in such a condi- 
tion as to be unable to borrow more than $100,000 from its 
banks. The estimated statement of profit and loss which 
will be given later will confirm the inadequacy of this cash 
balance. Revisions in the budgetary program which will 
accomplish its increase will be discussed subsequently. 

Notes Receivable and Accounts Receivable 

The notes receivable show an estimated increase of 50 
per cent, while the accounts receivable show a decrease. 
This is rather an unusual situation, since an increase in the 
volume of business should produce a corresponding increase 
in both. In the preceding discussion of the method of de- 
termining the amount of the notes receivable, it has been ex- 
plained that the statistics of past periods show a tendency for 
the sales for which notes are received in payment to increase 
faster than the sales on account. There may be conditions 
under which this tendency will not be regarded as undesir- 
able, but usually notes received in payment of merchandise 
are non-interest-bearing and are for a considerably longer 
length of time than the usual credit period granted on open 
account sales. Consequently the seller is required to bor- 
row funds with which to carry these notes or must discount 
them to obtain funds. In either case the interest charge 
must be borne by him which in turn reduces his profit. 
Unless a higher sales price is obtained for goods sold on 
notes, less profit is obtained usually than for goods sold on 
account. 

The estimated balance sheet shows such a radical change 
in the ratio of accounts receivable to notes receivable, that a 
careful examination should be made of the tendency shown 
by the comparisons of past periods to see whether the tend- 
ency for the notes receivable to increase more than in pro- 



ESTIMATED BALANCE SHEET 353 

portion to the accounts receivable should be permitted to 
continue, or whether strenuous efforts should be made to 
correct it by enforcement of stricter credit terms or by plac- 
ing more sales effort on other lines. 

Inventories 

The estimated inventories of December 31, 1922, are 
almost twice what the inventories are at the beginning of the 
year. The estimated increases in the inventories of raw 
materials and goods in process are no doubt the result of the 
estimated increase in production which is required to build 
up and maintain the large increase in finished goods for 
which the estimated balance sheet calls. Such an estimated 
increase in finished goods may result from the following: 

1. A large increase in sales may be estimated and this calls for an 

increased inventory. Whether the increase called for is jus- 
tified can be determined to some extent by considering the 
turnover shown by the estimated statement of profit and loss, 
and comparing this turnover with the turnover shown by pre- 
vious statements. 

2. It may be due to careless and inaccurate planning on the part of 

the production department. This department may not esti- 
mate accurately the required inventory of each item to be man- 
ufactured, not basing this estimate on the estimate of sales, but 
rather making a lump estimate of the inventory desired. 

A very careful investigation should be made to see (i) 
whether the estimated inventory is necessary in order to meet 
the estimated sales ; (2) whether it is possible to finance such 
an inventory, even if it is necessary to meet estimated sales; 
and (3) whether it is desirable to tie up so much capital in 
inventory, with the consequent carrying charges and the 
possibility of a large loss being incurred due to falling prices. 
It may be found more profitable and better financial policy 
to reduce sales and carry a smaller inventory. 

23 



354 iBlJDGEtARY CONTROL 

There is usually great danger attendant on such a rapid 
expansion as the increase in the inventories indicates that 
this company is contemplating. It is also significant to 
note that though the notes receivable and accounts receiva- 
ble have increased less than 8 per cent, the inventory of fin- 
ished goods has increased almost lOO per cent. This would 
seem to indicate that it is planned to increase the inventory 
of finished goods faster than is required by the sales program, 
since increased sales, without a change in terms or collection 
methods, will result in an increase in the accounts receivable 
and notes receivable. 

A statement of the suggested procedure for the company 
to follow in connection with its inventories will be postponed 
until after the estimated statement of profit and loss is con- 
sidered. 

Fixed Assets 

The estimated balance sheet shows a considerable increase 
in office equipment, machinery and equipment, and build- 
ings. In determining the propriety of these increases, it is 
necessary to consider the following: 

1 . Whether the increases shown represent anticipated expenditures 

which can properly be chargeable to the asset accounts. Care 
must be taken to see that they do not represent estimated 
appreciation on the assets or estimated expenditures for repairs 
or replacements. If these increases are based on the plant 
and equipment budget, it should be easy to determine their 
accuracy. 

2. Whether the estimated increases in these assets are necessary to 

carry on the contemplated program of the year. 

3. Whether, if they are necessary, it will be possible to finance them. 

4. Whether it will be profitable to incur these increases in order to 

carry on the contemplated program. 

The estimated depreciation should be investigated to see 
if it is calculated at the proper rate. The figures shown 



ESTIMATED BALANCE SHEET 355 

would seem to be reasonable in view of the estimated in- 
crease in assets. 

Deferred Charges to Expense 

The increase in the deferred charges would seem to be 
reasonable in view of the estimated increase in value of the 
assets on which insurance should be carried and the prob- 
ability of an increase in prepaid interest. To determine the 
desirability of the amount of the deferred charges to expense, 
it is necessary to consider the advisability of incurring the 
expenses which give rise to these charges. 

Notes Payable and Accounts Payable 

Turning to the liability side of the comparative balance 
sheet, it will be noticed that a larger increase in the notes 
payable is estimated. The notes payable of December 31 
are estimated to be almost five and one-half times the 
amount outstanding at the beginning of the year. An in- 
crease in the accounts payable is also estimated, but this 
increase is by no means in proportion to the contemplated 
increase in notes payable. An analysis should be made to 
show to whom it is planned to issue these notes. It is re- 
garded as good financial management to borrow funds on 
notes issued to banks and to use these funds to discount 
accounts payable. An inspection of the item of purchases 
discount on the comparative statement of profit and loss 
which will be shown in Figure 40 (page 363), will serve to 
show^ whether this procedure is contemplated. If it is, the 
estimated purchases discount should show a large increase 
over the amount of last year. 

There are indications that it is contemplated to con- 
tract large bank loans in order to pay accounts payable 
contracted to secure the large increase in inventories. If 
this be true, there is considerable doubt of the advisability 



356 BUDGETARY CONTROL 

of the contemplated large increase in bank loans. In the 
first place, it is doubtful whether banks would loan the 
amount called for by the estimated balance sheet on the 
strength of the financial condition shown by this statement. 
In the second place it is doubtful if the firm should contract 
such a large amount of loans in order to carry large inven- 
tories. If the inventories are not converted very rapidly, 
the firm may be unable to meet the notes at maturity. 

Fixed Liabilities 

It is estimated that the bonds payable and mortgages 
payable will both increase during the year. Presumably 
the funds to be secured from these increases are to be used in 
making the increase to the fixed assets. If the increases in 
fixed assets are found to be justifiable, it may not be im- 
proper to increase the fixed liabilities correspondingly. 
However, the more desirable procedure is for a business to 
increase its permanent assets out of profits. A rapidly ex- 
panding business will often find this impossible, and if there 
is assurance that a rapid expansion will be profitable, no 
objection can be made to the procedure contemplated by 
this company. 

It must be remembered, however, that fixed liabilities 
impose upon a business fixed charges which must be met 
if the business is to continue to operate, and that fixed 
liabilities are not subject to rapid contraction as are current 
liabilities. A business should therefore be cautious in 
adopting a program which necessitates an increase in its 
fixed liabilities. 

Capital Stock 

The estimated balance sheet shows an increase in capital 
stock of $250,000. This increase strengthens the indications 
of the other comparisons that the company is embarking on 



ESTIMATED BALANCE SHEET 357 

an extensive program of expansion. If its plans are depend- 
ent on the sale of stock, it should be assured, before em- 
barking upon its year's program, that the stock can be sold. 
Otherwise it may find itself greatly embarrassed because 
the estimated balance sheet shows that the company has 
used practically every other available source of additional 
capital. 

Surplus 

The estimated balance sheet shows a large decrease in 
the surplus for the year. This decrease may result (a) 
from a loss being incurred during the year ; (b) from the pay- 
ing of dividends in excess of the profits of the year. Either 
condition indicates an undesirable situation. To incur a 
loss is always undesirable. There are times when it may be 
desirable to pay dividends from accumulated profits, but 
the balance sheet of this company does not indicate such 
a procedure is desirable for it. 

In the first place, the surplus of the company is not large 
in comparison to its capital stock. Secondly, the company 
is planning to issue new stock and additional bonds to obtain 
necessary capital. It is also planning to contract large 
liabilities in the form of notes payable. Under such condi- 
tions it is doubtful if it is expedient to use funds to pay 
dividends which are declared from profits of preceding years. 

Ratio of Current Assets to Current Liabilities 

A final comparison which is of considerable significance 
is that of the ratio of current assets to current liabilities. 
On December 31, 1921, this ratio is slightly more than 4 to 
I, while the estimated balance sheet of December 31, 1922, 
shows a ratio of only 2K to i . It can be seen, therefore, that 
there is a decided decrease in this ratio. Although the 
ratio on December 31, 1922, does not in itself appear unfa,- 



358 BUDGETARY CONTROL 

vorable, the tendency indicated by the decrease in this ratio 
during the year is decidedly undesirable. If possible, 
changes should be made to prevent this decided decrease in 
this ratio. In any case, care must be exercised to see that 
this tendency does not continue. 

It is of course realized that no standard ratio of current 
assets to current liabilities can be established. This ratio 
will vary from business to business, and will vary in the same 
business at different stages of the business cycle. 



CHAPTER XXII 

THE ESTIMATED STATEMENT OF PROFIT 

AND LOSS 

Contents of the Estimated Statement of Profit and Loss 

The estimated statement of profit and loss is prepared 
in the same form as the periodical statement. Its contents 
is classified into the following principal groups: 

1. Returns from sales 

2. Cost of goods sold 

3. Operating expenses 

4. Non-operating income 

5. Non-operating expense 

It is necessary to discuss briefly the method of estimating 
the amount of each of these. 

Returns from Sales 

The estimated sales for the period are shown by the 
sales estimate. The estimate shows the gross sales, and 
for the purpose of the estimated statement of profit and 
loss it is necessary to arrive at the net sales. This makes it 
necessary to determine the amount of the sales returns and 
sales allowances. An estimate of these can be made by ob- 
taining their ratio to sales during past periods, and apply- 
ing this ratio to the estimated sales for the current period. 
If there are conditions which will affect this ratio during the 
coming period, these will need to be given consideration. 

The estimated sales and the estimated returns and 
allowance of the National Manufacturing Company are 
shown in the comparative statement of profit and loss 
shown in Figure 40. 

359 



36o BUDGETARY CONTROL 

Cost of Goods Sold 

In calculating the cost of goods sold of a manufacturing 
business, several items have to be considered. These in- 
clude the beginning and ending inventories of finished goods, 
materials, and goods in process. In addition it is necessary 
to know the purchases of materials, labor, and manufactur- 
ing expense. The method of calculating the inventories 
has been explained ii> the discussion of the estimated balance 
sheet. The estimated purchases of materials, labor, and 
manufacturing expense can be taken from the materials, 
labor, and manufacturing expense budgets, respectively. 

In a mercantile business the problem is much simpler 
than in the manufacturing business. It is necessary to 
consider only the beginning and ending inventories and the 
purchases of finished goods. If a finished goods schedule 
such as that discussed in Chapter XIV is prepared, all this 
information can be taken directly from it. 

The estimated cost of goods of the National Manufactur- 
ing Company is shown in the comparative statement of 
profit and loss given in Figure 40. 

Operating Expenses 

The amount of each class of expense can be obtained 
from the various expense budgets. The only difficulty 
which may arise in this connection is that the expense 
classification shown by the expense budgets may not 
correspond with that usually shown on the statement of 
profit and loss. This is particularly true if the expense 
budgets are made according to the classification of expenses 
suggested in Chapter XVIII. For instance, under cor- 
porate and financial expenses will be included items which 
are often shown as non-operating expenses. 

It is the author's belief that some such classification as 
that suggested in the discussion of the expense budgets is 



ESTIMATED PROFIT AND LOSS 361 

desirable for control purposes, and that it is preferable 
that the estimated statement of profit and loss show the 
same classification. If desirable a different classification 
may be shown on the financial statements submitted for 
public use. 

The statement presented below shows the estimated 
expenses of National Manufacturing Company, classified 
under the principal headings suggested in Chapter XVIII. 
The expense estimates will supply the supporting data to 
make possible a judgment as to the propriety of these 
amounts. 

Non-Operating Income 

The non-operating income can be obtained by simple 
calculations based on the information contained in the 
various budgets. For instance, the purchases discount can 
be estimated by applying the ratio of purchases discount to 
the total purchases of previous years, to the estimated pur- 
chases of the current year. Interest earned can be cal- 
culated on the basis of the sales estimate and the ratio of 
interest received to sales during preceding years. This 
method is based on the assumption that the terms of sales 
and rate of interest on notes receivable will remain the same. 
Contemplated changes in policy must be given effect in 
making these estimates. 

Such changes are contemplated by the National Manu- 
facturing Company, which accounts for a decrease in the 
amount of these items on its estimated statement of profit 
and loss, as shown in Figure 40. 

Non-Operating Expense 

If the expense classification previously suggested is 
maintained, there will not be many items under non-operat- 
ing expense. Those that are shown here can be easily 



362 BUDGETARY CONTROL 

estimated. For instance, if it is desired to show sales dis- 
count as a non-operating expense, its amount can be esti- 
mated by applying the ratio of sales discount to the total 
sales during previous years, to the estimated sales of the 
current year. 

Interpretation of the Estimated Statement of Profit and Loss 

The most convenient and effective way to show the 
effect of the proposed budgets on the profits of the business 
is to show the estimated statement of profit and loss as 
of the end of the period, in comparison with the actual 
statement of profit and loss at the beginning of the period. 
The statement of profit and loss of the National Manu- 
facturing Company as of December 31, 1921, and its esti- 
mated statement of profit and loss as of December 31, 1922, 
are shown in Figure 40. The most important comparison 
shown by the statements will be considered. 

Sales 

The estimated sales show an increase of 50 per cent. 
This in itself looks very favorable, but the result of these 
sales in terms of profit and loss must be considered before a 
final conclusion can be made. 

Turnover 

The merchandise turnover for the year 1921 is 3.4, while 
for the year 1922 it is estimated to be only 2.5. This 
comparison shows a decided decrease in the rate of turnover 
which should be given careful consideration. The relation 
of this decrease in turnover to the inventories will be ex- 
plained later in this discussion. 

Gross Profits on Sales 

The gross profits on sales in 1921 are approximately 123^8 
per cent of sales, while the estimated gross profits for 1922 



ESTIMATED PROFIT AND LOSS 363 



COMPARATIVE STATEMENT OF PROFIT AND LOSS 

FOR THE 

NATIONAL MANUFACTURING COMPANY 


Gross Sales 


1921 

$1,600,000 


19 

40,000 
962,000 

,002,000 
70,000 


22 

$2,400,000 
24,000 

$2,376,000 


Less: Sales Returns and Allowances 


16,000 


Net Sales 


$1,584,000 


Cost op Goods Sold: 
Raw Materials, Beginning Inventory 




.. $ 18,000 $ 


$ 932,000 

1,130,000 

700,000 

$2,762,000 
120,000 


Purchases 

Raw Materials, Inventory End of Period 


. . 600,000 


$ 618,000 $1 
40,000 


Raw Materials Used 




$ 578,000 


Labor Used 


625,000 


Manufacturing Expense 


575,000 


Work in Process, January 1 




$1,778,000 
50,000 


Work in Process, December 31 




$1,828,000 
120,000 


$2,882,000 
230,000 


Cost of Goods Manufactured 




$1,708,000 


$2,652,000 
560,000 


Finished Goods, Beginning Inventory 

Finished Goods, Inventory End 


240,000 


$1,918,000 
560,000 


$3,212,000 
1,100,000 


Cost of Goods Sold 




$1,388,000 


$2,112,000 
$ 264,000 


Gross Profit on Sales 

Operating Expenses: 
Selling Expenses 


$ 196,000 


$ 44,000 


$ 85,000 
47,500 
41,500 
23,000 
19,000 


Financial Expenses 


30,500 


Executive Expenses 


25,000 


Corporate Expenses 


18,000 


Total Operating Expenses 


10,500 


$ 128,000 


$ 216,000 


Net Operating Profit 




$ 68,000 


$ 48,000 
20,800 


Non-Operating Income 


24,800 


Gross Income 




$ 92,800 


$ 68,800 
53,600 


non-operatxng expense 

Net Income 


31,000 
$ 61,800 


$ 15,200 











Figure 40. Comparative Statement of Profit and Loss, with 
Preliminary Estimate 



364 BUDGETARY CONTROL 

are only 1 1 per cent of sales. This indicates that the esti- 
mated production cost of goods sold increases faster than 
the estimated sales price of sales. Or if falling prices are 
anticipated, it may be estimated that the sales price will 
fall faster than the production cost. This may be a situa- 
tion which is unavoidable, but careful scrutiny should be 
made to determine some means by which it may be remedied. 
The tendency indicated by this comparison is a dangerous 
one, and one which is apt to occur if there is not close co- 
operation between sales and production departments. 

Ratio of Selling Expenses to Sales 

The selling expenses are .027 of sales for the year 1921, 
but according to the estimated statement of profit and loss 
are to be .035 for the year 1922. This shows that though 
the sales are expected to increase, the proposed marketing 
plans are such that it will cost more to secure each dollar 
of sales than during the last year. An analysis of the sales 
expense will probably show that this increase is due to the 
estimated extra cost of salesmen's salaries and expenses and 
of advertising. It may be planned to incur these increased 
expenses to obtain additional business and build up good- 
will for the company. It may be proper to increase these, 
but the tendency for such expenses to increase faster than 
sales increase is a dangerous one, and care should be taken 
that it does not continue too long. 

Operating Expenses 

The total operating expenses for 1921 are 8 per cent of 
sales, while for the year 1922, it is estimated that they will 
be 9 per cent. Although this increase is not large it shows 
an undesirable and a dangerous tendency, and a careful 
examination should be made to see if it is possible to change 
this condition before the budgets are approved, 



ESTIMATED PROFIT AND LOSS 365 

Net Operating Profit 

The net operating profit for 1921 is 4 per cent of sales, 
while it is estimated to be but 2 per cent of sales for the 
year 1922. It is also estimated to be smaller in amount in 
1922 than in 1921. This is the most discouraging informa- 
tion shown on the comparative statement of profit and loss. 
When it is estimated that the sales will increase 50 per cent, 
it is decidedly unsatisfactory to find an estimated decrease 
in net profit. It may of course be found that some of the 
expenses to be incurred during the coming year are expected 
to result in increased business during future years. If this 
be true, there may be some excuse for the unprofitable 
showing, but a careful examination should be made to 
ascertain if this is the situation. 

Non-operating Expense 

It is estimated that there will be a large increase in the 
non-operating expenses for the year. This increase is 
probably due to the anticipated increase in interest result- 
ing from the additional bonds and notes which are to be 
issued, and the increase in the amount of the mortgages 
payable. 

Net Income 

The estimated net income for 1922 is approximately 
one-fourth of the net income for the year previous. This 
indicates that the proposed program for the year is not a 
proper one, since a 50 per cent increase in volume of busi- 
ness leads to a 75 per cent decrease in net income. 

Relation of Estimated Balance Sheet to Estimated Statement of 
Profit and Loss 

If the comparative balance sheet given in Chapter 
XXI is studied in connection with the comparative state- 



366 BUDGETARY CONTROL 

ment of profit and loss shown in this chapter, a few signifi- 
cant indications are shown: 

1. The comparative statement of profit and loss con- 
firms the indications of the comparative balance sheet that 
a large increase in business is contemplated. It shows that 
the budgets are all based on a policy of expansion. 

2. The comparative balance sheet shows a large antici- 
pated increase in inventory of finished goods and an increase 
which is much larger proportionally than the anticipated 
increase in sales, as shown by the comparative statement of 
profit and loss. Whereas it is estimated that the sales will 
increase 50 per cent, it is estimated that the inventory of 
finished goods will increase almost 100 per cent. The 
comparative statement of profit and loss shows a decrease 
in the merchandise turnover. It is hard to conceive of 
conditions which would necessitate such a change in the rate 
of turnover in one year. These comparisons show rather 
conclusively that the proposed production program is out 
of harmony with the sales program and should be cut down. 

3. The comparative balance sheet shows an estimated 
decrease in surplus of $104,000. The comparative state- 
ment of profit and loss shows a profit for the year of $15,200. 
It is evident, therefore, that it is planned to pay dividends 
which will necessitate the distribution of a considerable part 
of the accumulated surplus. The financial condition of the 
business, as shown by the comparative balance sheet, 
indicates that such a procedure would be unwise. 

Revision of Departmental Estimates 

It is very probable that a study of the estimated balance 
sheet and the estimated statement of profit and loss would 
lead to a revision of the departmental estimates on which 
these statements are based. This revision is necessary for 
three reasons: 



ESTIMATED PROFIT AND LOSS 367 

1. The estimated balance sheet shows that the contemplated pro- 

gram for the year will result in the firm's showing an unsatis- 
factory financial condition at the end of the year. 

2. The estimated statement of profit and loss shows that the con- 

templated program will result in an unsatisfactory profit for 
the year. 

3. The financial budget shows that the financial requirements of 

the proposed program would probably be larger than the 
firm could finance. As already pointed out, the financial 
condition of the firm, as shown by its estimated balance sheet, 
does not warrant the procurement of the quantity of loans for 
which the balance sheet calls. 

Some of the revisions which may possibly be made are : 

1. The sales program will be scrutinized very carefully to determine 

if all the sales for which it calls can be made profitably. If 
not, those which are not profitable will be eliminated. 

2. The sales program will also be examined to see if it is not possi- 

ble to increase sales to be made on short-term credit and to 
reduce those made on long-term credit. Any possible changes 
will be made. 

3. The estimated inventory of finished goods will be cut down to 

be in harmony with the sales program. This will result in 
a decrease in the production program, with a consequent 
decrease in labor, materials, and manufacturing expense cost. 

4. If possible, the plant and equipment program will be cut down. 

This will be all the more possible because of the decrease in the 
production program. 

5. The proposed dividend may be passed. 

6. The operating expense estimates will be reduced, if possible, so 

that the ratio of operating expenses to sales will not be in 
excess of the previous year, and, if possible, so that it will be 
smaller. 

7. Based on the foregoing revisions, the financial budget will be 

revised. 

Preparation of the Estimated Financial Reports 

The preceding discussion has indicated the method by 
which the estimated balance sheet and statement of profit 



368 BUDGETARY CONTROL 

and loss are prepared and the manner in which they may 
be interpreted. In order to make the discussion as concrete 
as possible, assumed statements were taken and an interpre- 
tation of these made. It should be evident to the reader 
that such an interpretation may lead to erroneous con- 
clusions when taken by itself. The foregoing case is given to 
indicate the method by which statements should be analyzed 
rather than to emphasize the value of the particular conclusions 
drawn from the analysis. 

There may be a difference of opinion with reference to 
the placing of the responsibility for the preparation of the 
estimated statements. It is necessary to use the various 
departmental estimates in their preparation, and the execu- 
tive in charge of the budgetary procedure is the only one 
to whom all these come automatically. A saving of time 
results, therefore, if this executive is held responsible for 
their preparation. After they are completed he may well 
submit them to the controller and the treasurer for con- 
sideration and suggestions. 

The executive in charge of the budgetary procedure will 
prepare preliminary estimated financial statements and 
submit them to the budget committee at the time he sub- 
mits the departmental estimates and the estimates of cash 
receipts and disbursements. After the budget committee 
has approved the departmental estimates, he will revise 
the estimated financial statements to give effect to the 
changes which have been made in the departmental 
budgets. 

Control of the Estimated Financial Statements 

The estimated financial statements, like all other esti- 
mates, must be compared with results obtained at frequent 
intervals, if effective control is to be exercised over their 
use. Both the estimated balance sheet and the estimated 



ESTIMATED PROFIT AND LOSS 



369 



statement of profit and loss should be compared at the end 
of each budget period with the actual balance sheet and 
actual statement of profit and loss as of that date. This 
comparison will be more significant if the actual financial 
statements at the beginning of the year are included. 



NATIONAL MANUFACTURING COMPANY 
Actual and Estimated Balance Sheet as of the Dates Stated 




Actual 
Dec. 31. 1921 


Estimated 
Dec. 31, 1922 


Actual 
Dec. 31, 1922 


Current Assets 
Deferred Charges 
Fixed Assets 
Intangible Assets 

Total Assets 

Current Liabilities 
Fixed Liabilities 
Deferred Credits 

Total Liabilities 
Proprietorship 

Total Liabilities and 
Proprietorship 







































Figure 41 . Comparison of Actual and Estimated Balance Sheets 



A report showing proper comparisons for the balance 
sheet may be made in the form shown in Figure 41. 

A similar report can be made on the statement of profit 
and loss in the form shown in Figure 42. 



24 



370 BUDGETARY CONTROL 

The reports shown in Figures 41 and 42 should be pre- 
pared by the executive in charge of the budgetary proce- 
dure and submitted to the budget committee at the time 
the other budget reports are transferred to it. 

The **General Budget" 

Both practitioners and writers sometimes refer to the 
"general budget." The estimated balance sheet and esti- 
mated statement of profit and loss is the most convenient 
form in which to prepare the general budget. These state- 
ments show the effect of the proposed program, as expressed 
in the departmental estimates, on the financial condition 
and earnings of the firm, and this is the information which 
the executives and board of directors need in order to 
judge the advisability of the contemplated plans. 

If the budget committee and the board of directors 
study carefully the financial budget and the estimated 
financial statements, together with departmental estimates 
which support these, they should have no difficulty in secur- 
ing the information necessary for effective administrative 
control. 

Branch and Division Budgets 

Where a business has branches, divisions, or subsidiary 
companies, it may desire to have separate budgets prepared 
for each. In this case separate sales estimates, production 
estimates, plant and equipment estimates, etc., may be 
prepared for each unit and these may be consolidated to 
form a financial budget and estimated financial statements 
for each. 

The estimates of each unit will be submitted separately 
to the budget committee, and in addition they will be com- 
bined to form the estimates for the company as a whole. 
This procedure enables the budget committee and board of 



ESTIMATED PROFIT AND LOSS 



371 



NATIONAL MANUFACTURING COMPANY 

Actual and Estimated Statements of Profit and Loss as of the Dates Stated 






Actual 
1921 


Estimated 
1922 


Actual 
1922 


Gross Sales 

Returns and allowances 

Net Sales 

Cost of Goods Sold 

Gross Profit on sales 

Operating expenses 
Selling Expenses 
Financial Expenses 
Executive Expenses 
Corporate Expenses 

Total Operating Expenses 
Net Operating Profit 
Non-operating Income 
Gross Income 
Non-operating Expense 
Net Income 













































































Figure 42. Comparison of Actual and Estimated Statements of Profit and Loss 



372 BUDGETARY CONTROL 

directors to judge better the contemplated program, since 
they can pass judgment on each unit separately. It also 
facilitates the enforcement of the estimates, since responsi- 
bility for the variations between the estimated and the 
actual can be definitely fixed. 

Summary 

The purpose of the foregoing discussion is to explain 
and illustrate the use of the estimated balance sheet and 
estimated statement of profit and loss in business planning 
and administration. More particularly it attempts to show 
their relation to the general budgetary plans of the business. 
The development of the use of financial reports as a basis 
of management may be divided into three stages : 

1. Business men learned to use the balance sheet which shows them 

where they are at a specific date. 

2. They learned to use the statement of profit and loss which shows 

them how they got to where they are. 

3. They are just now learning to use the estimated balance sheet 

and estimated statement of profit and loss which shows them 
where they are going and how they are to get there. 

The slow growth of the use of the estimated balance 
sheet and estimated statement of profit and loss has no 
doubt been due in part to the attitude maintained by public 
accountants that the function of the accountant is to make 
statements showing the results of past operations, and not 
to prophesy as to what will happen in the future. This 
attitude is due probably to the realization that, since they 
are not connected with the business, they have no control 
over its future operations, and therefore cannot safely pre- 
dict their result. They feel that such statements on their 
part might be used to mislead the public and this would 
react to their disfavor. Although the public accountant 
may be justified in this attitude because of the particular 



ESTIMATED PROFIT AND LOSS 373 

relations existing between him and his client, this in no 
way detracts from the value of the estimated financial 
statement as a basis of managerial control. 

The bookkeeper has also failed to prepare estimated 
financial reports because he makes up his reports from the 
accounts, and the accounts do not reflect the decisions of 
the executives of the company with reference to results 
expected. 

No doubt in the not distant future both the accountant 
and the business man will come to realize that all financial 
statements are but estimates, and although estimates of 
past results as shown by the standard balance sheet and 
statement of profit and loss may be more exact, estimates 
of future results may be equally useful. 



CHAPTER XXIII 
MANUAL OF BUDGETARY PROCEDURE 

Need for Manual 

As shown by the discussion in the preceding chapters, 
the procedure involved in the preparation and execution of 
the various departmental budgets is a comprehensive and 
complex one. It requires the cooperation of the various 
functional executives, and a very definite coordination of 
the activities of the functional departments. The success 
of the budgetary program is dependent on this cooperation 
and coordination. If any part of the procedure fails, it dis- 
rupts the remainder. 

For these reasons it is desirable that the budgetary pro- 
cedure be very carefully worked out and reduced to written 
form, so that all executives and employees concerned may 
be fully cognizant of it. This can be most easily done by 
the preparation of a manual on budgetary procedure. 

Contents of Manual 

The contents of a manual on budgetary procedure will 
vary from business to business, depending on the volume 
and nature of the operations performed and upon the 
organization by which the operations are carried on. In 
a manufacturing business it is usually desirable that the 
manual discuss the following: 

1 . Organization for Budgetary Control 

2. The Sales Budget 

3. The Production Budget 

4. The Labor Budget 

5. The Manufacturing Expense Budget 

374 



MANUAL OF BUDGETARY PROCEDURE 375 

6. The Materials Budget 

7. The Plant and Equipment Budget 

8. The Expense Budgets 

9. The Financial Budget 

10. The Estimated Financial Statements 

Illustration of Manual 

To show concretely the possible contents of a manual 
on budgetary procedure, there is given below the manual 
of a manufacturing company. The company has sales of 
about $6,000,000 a year. Part of the product of the com- 
pany is sold direct to the consumer, while the remainder is 
sold to merchants. Branches are used to market part of the 
goods. 

The president, who is also treasurer, does not reside in 
the city where the company is located but maintains an 
active interest in its affairs. The assistant treasurer is gen- 
eral manager; the other principal executives are the sales 
manager and works manager. The assistant to the general 
manager serves as office manager and head of the account- 
ing and statistical departments. The company's accounting 
period is four weeks and its budget period is three accounting 
periods. 

I. Organization for Budgetary Control 

1. The President 

The President of the Company is to have direct control of all matters 
pertaining to the budgetary program. All officers to whom authority is 
delegated in this manual are acting as his agents and are responsible to him 
for the proper performance of the duties delegated to them. In all cases 
of disagreement between departments with reference to the coordination of 
estimates, the decision of the President will be final. 

2. The General Manager 

The General Manager will be the representative of the President in all 
matters pertaining to the budgetary program and will have such authority 
in connection therewith as the President may see fit to delegate to him. 



376 BUDGETARY CONTROL 

In all matters so delegated, the decision of the General Manager will have 
the same authority as that of the President. 

3. The Budget Committee 

The General Manager, the Works Manager, and the Sales Manager 
will constitute a Budget Committee which will have supervision of the 
budgetary program. The Assistant to the General Manager will be secre- 
tary of this committee. 

Under the authority and direction of the President, the Budget Com- 
mittee is to consider all departmental estimates and to make such changes 
and revisions as it may think desirable. No estimate is to be effective until 
it has received the approval of the Budget Committee. The Committee 
will receive all estimates from the Assistant to the General Manager and 
will transmit the estimates as approved by it to him. In case the Budget 
Committee cannot agree with reference to any estimate, the question in 
dispute is to be submitted to the President and his decision will be final. 

In the consideration of the departmental estimates, the Budget Com- 
mittee may call on departmental heads to explain the reasons for the varia- 
tions in their estimates from the estimates of past periods. 

The Committee will receive through the Assistant to the General Man- 
ager periodic reports showing comparisons of the performance for the past 
period with the estimated performance of that period. On the basis of 
these reports, it may make revisions in the budgets for the remainder of 
the budget period, if it deems such revisions necessary. 

4. The Assistant to the General Manager 

Under the authority and direction of the General Manager, the Assist- 
ant to the General Manager will have general control and supervision over 
the preparation and execution of the budgetary program. His general 
duties are outlined in the several sections of this manual. 

These duties may be summarized as follows: 

(i) To receive from the departmental heads the periodic estimates 
as provided for in this manual. 

(2) To prepare from these estimates (a) estimate of cash receipts, 

(b) estimate of cash disbursements, (c) estimated balance 
sheet, and (e) estimated statement of profit and loss. 

(3) To transmit all the estimates to the Budget Committee with 

such recommendations as he may think necessary. 

(4) To receive from the Budget Committee the estimates as ap- 

proved and to transmit these to the departmental heads. 



MANUAL OF BUDGETARY PROCEDURE 377 

(5) To receive periodic reports prepared by the operating depart- 

ments or the accounting department showing the depart- 
mental performance for the month. 

(6) To transmit the periodic reports to the Budget Committee 

showing the comparison between the estimated performance 
and the actual performance for the period for each depart- 
ment, and to make such recommendations as he may deem 
necessary. 

(7) To transmit to departmental heads any revisions in the original 

estimates which have been made by the Budget Committee. 

(8) To recommend to the General Manager and to the Budget 

Committee such changes in the budgetary procedure as he 
may deem desirable. 

He has the implied authority to do all things which are necessary to the 
proper performance of these duties. 

5. The Departmental Heads 

The executive heads of the various departments are responsible for the 
preparation of the estimates of their departments at the time and in the 
manner prescribed in this manual. They are also responsible for the prep- 
aration of the reports called for in this manual. Any recommendations 
which any departmental executive desires to make with reference to changes 
in budgetary procedure will be transmitted in writing to the Assistant to 
the General Manager. It will be referred by him to the Budget Committee 
for consideration. 

The responsibility for the preparation of the departmental estimate and 
the periodic report is in each case placed upon the head of the department. 
He may employ his assistants in their preparation at his discretion, but the 
responsibility rests on the executive head in each case. 

n. The Sales Budget 

I . Preparation of Sales Estimate 

The Sales Manager wall prepare for each budget period the estimate of 
the sales for that period. In the preparation of this estimate he will take 
into consideration: 

(i) The sales of past periods 

(2) The present market conditions 

(3) The contemplated plans and policies of the business for future 

periods 



378 BUDGETARY CONTROL 

2. Form of Estimate 

The estimate of sales will be made in such form as to show the antici- 
pated sales to : 

(i) Hospitals 
(2) Merchants 

It will also show the anticipated sales of each principal grade of goods 
sold. The first classification is necessary in order that the financial budget 
may be made, since the sales to hospitals are of different terms than the 
sales to merchants. The second classification is necessary in order that 
production may be planned so as to have on hand the proper quantity of 
the different grades. A form to be used in the submission of the sales esti- 
mate will be provided by the Assistant to the General Manager. 

3. When Submitted 

The Sales Manager will transmit the sales estimate with his approval 
to the Assistant to the General Manager on or before the first day of the 
third week preceding the beginning of the budget period. 

4. Procedure by the Assistant to the General Manager 

The Assistant to the General Manager will transmit a copy of the 
sales estimate to the Works Manager within two days after the receipt of 
the original estimate from the Sales Manager. He will transmit the origi- 
nal estimate, together with all the other estimates called for in this manual, 
to the Budget Committee on or before the first day of the first week preced- 
ing the beginning of the budget period. 

5. Approval by the Budget Committee 

The Budget Committee will make such revisions as it thinks necessary 
in the sales estimate, and will transmit the revised estimate with its ap- 
proval to the Assistant to the General Manager within two days after it 
receives this estimate. In making its revisions the Budget Committee will 
make specific changes of particular amounts instead of making a percent- 
age revision of the estimate as a whole. 

6. Transmission to the Selling Department 

The Assistant to the General Manager will transmit the revised estimate 
to the Sales Department immediately upon its receipts from the Budget 
Committee. This estimate as revised and approved by the Budget Com- 
mittee will constitute the budget of the sales department for the next budget 



MANUAL OF BUDGETARY PROCEDURE 379 

period. Copies of this estimate should be sent by the Sales Department to 
the Manager of each branch, indicating the quota of the branch based on 
this estimate. 

7. Periodic Report from the Statistical Department 

At the end of each period the statistical department will send to the 
Assistant to the General Manager a report showing the sales made during 
the period. This report will be forwarded on or before the fifth working 
day of the period following the period for which it is made. 

8. Periodic Report to the Budget Committee 

On or before the tenth day of each period, the Assistant to the General 
Manager will transmit to the Budget Committee a report showing a com- 
parison of the estimated and actual sales for the past period. He will ac- 
company this report with any recommendations which he may think de- 
sirable. 

9. Revision of Sales Budget by Budget Committee 

On or before the twelth day of the period, the Budget Committee will 
consider the report received from the Assistant to the General Manager, 
and will make such changes as it deems desirable in the sales budget for 
the remainder of the budget period. These changes will be communicated 
to the sales department by the Assistant to the General Manager on or be- 
fore the fifteenth day of the period. 

III. The Production Budget 

I . Estimate of Finished Goods 

On or before the third day of the third week preceding the beginning of 
the budget period, the Works Manager will receive from the Assistant to 
the General Manager the estimate of sales prepared by the Sales Manager. 
Based on this estimate the Works Manager will prepare an estimate of the 
finished goods which must be produced in the next budget period to meet 
sales demands. In making this estimate the estimated inventory of fin- 
ished goods on hand at the beginning of the period and the desired inven- 
tory of finished goods at the end of the period will be taken into consid- 
eration. The requirements of the sales department for the period plus the 
estimated inventory at the end of the period, minus the estimated inven- 
tory at the beginning of the period, will equal the estimated production of 
finished goods for the period. 



38o BUDGETARY CONTROL 

2. Transmission to the Assistant to the General Manager 

The Works Manager will transmit the estimate of production as pre- 
pared under the preceding section, to the Assistant to the General Manager 
within one week after the receipt of the sales estimate from the Assistant 
to the General Manager. 

3. Approval by the Budget Committee 

The Assistant to the General Manager will transmit the estimate 
of production to the Budget Committee on or before the first day of 
the first week preceding the beginning of the budget period. He may ac- 
company this estimate with such suggestions or recommendations as he may 
think desirable. The Budget Committee will make such changes as it may 
deem desirable in the estimate, and return it with the Committee's approval 
to the Assistant to the General Manager within two days after its receipt 
by the Committee. The Assistant to the General Manager will imme- 
diately transmit it to the Works Manager. 

4. Periodic Report from the Production Department 

At the end of each period, the Works Manager will send to the Assist- 
ant to the General Manager a report showing the production for the period. 
This report will be forwarded on or before the fifth working day of the 
period following the period for which it is made. 

5. Periodic Report to the Budget Committee 

On or before the tenth day of each period, the Assistant to the General 
Manager will transmit to the Budget Committee a report showing a com- 
parison of the estimated with the actual production for the past period. 
He will accompany this report with any recommendations which he may 
think desirable. 

6. Revision of Production Budget by Budget Committee 

On or before the twelfth day of the period, the Budget Committee will 
consider the report received from the Assistant to the General Manager 
and will make such changes as it deems desirable in the production budget 
for the remainder of the period. These changes Will be communicated to 
the Works Manager by the Assistant to the General Manager. 

IV. The Labor Budget 
I . Estimate of Labor Cost 

On or before the tenth day preceding the beginning of the budget period, 
the Works Manager will send to the Assistant to the General Manager an 



MANUAL OF BUDGETARY PROCEDURE 3S1 

estimate of the cost of factory labor for each month of the next budget period. 
This estimate will be based on the estimate of production which is pre- 
pared by the production department in the manner indicated in Section III 
of this manual. The Works Manager will be assisted by the Employment 
Department in the preparation of this estimate. The estimate of labor 
cost will be made on a form provided by the Assistant to the General Man- 
ager. It will have the following columnar headings: 

(i) Department 

(2) Same period last year 

(3) Average for last four budget periods preceding the one during 

which the budget is prepared 

(4) Estimated cost for this period 

(5) Distribution: 

(a) First period 

(b) Second period 

(c) Third period 

Columns (2) and (3) will be filled in by the Assistant to the General 
Manager prior to sending the form to the Works Manager. 

2. Approval by the Budget Committee 

On or before the first day of the first week preceding the beginning of 
the budget period, the Assistant to the General Manager will transmit the 
estimate of labor costs as prepared by the Works Manager to the Budget 
Committee, with such recommendations as he may deem necessary. The 
Budget Committee will make such changes as it may deem expedient, and 
return the estimate with its approval to the Assistant to the General Man- 
ager within two days after its receipt by the Committee. 

The Assistant to the General Manager will return the estimate of labor 
cost as approved by the Budget Committee, to the Works Manager imme- 
diately upon its receipt from the Committee. 

3. Periodic Report on Labor Costs 

On or before the eighth day of each period, the Works Manager will 
send to the Assistant to the General Manager a report showing the cost of 
factory labor for the preceding period. The Assistant to the General Man- 
ager will supply the form for the submission of this report. 

On or before the tenth day of the period, the Assistant to the General 
Manager will transmit a report to the Budget Committee showing a com- 
parison between the estimated labor costs for the past period and the actual 
costs as reported by the Works Manager. If the Budget Committee de- 



382 BUDGETARY CONTROL 

sires to make any recommendations to the Production Department with 
reference to labor cost during the remainder of the budget period, these 
recommendations will be communicated to the Works Manager through 
the Assistant to the General Manager on or before the twelfth day of the 
period. 

V. Manufacturing Expense Budget 

1. Estimate of Manufacturing Expense 

On or before the tenth day preceding the beginning of the budget period, 
the Works Manager will send to the Assistant to the General Manager an 
estimate of manufacturing expense for each month of the next budget period. 
In preparing this estimate he will be assisted by the cost accounting 
department. This estimate will be based on the estimate of production 
which is prepared by the production department in the manner indicated in 
Section III of this manual. The estimate of manufacturing expense will 
be made on a form provided by the Assistant to the General Manager. It 
will have the following columnar headings: 

(i) Department 

(2) Same period last year 

(3) Average for last four budget periods preceding the one during 

which the budget is prepared 

(4) Estimated cost for this period 

(5) Distribution: 

(a) First period 

(b) Second period 

(c) Third period 

Columns (2) and (3) will be filled in by the Assistant to the General 
Manager prior to sending the form to the Works Manager. 

2. Approval by the Budget Committee 

On or before the first day of the first week preceding the beginning of 
the budget period, the Assistant to the General Manager will transmit the 
estimate of manufacturing expense as prepared by the Works Manager to 
the Budget Committee, with such recommendations as he may deem neces- 
sary. The Budget Committee will make such changes as it may deem 
expedient and return the estimate with its approval to the Assistant to the 
General Manager within two days after its receipt by the Committee. 

The Assistant to the General Manager will return the estimate of man- 
ufacturing expense as approved by the Budget Committee to the Works 
Manager immediately upon its receipt from the Committee. 



MANUAL OF BUDGETARY PROCEDURE 383 

3. Periodic Report on Manufacturing Expense 

On or before the eighth day of each period, the Accounting Department 
will send to the Assistant to the General Manager a report showing the 
manufacturing expense for the preceding period. The Assistant to the 
General Manager will supply the form for the submission of this 
report. 

On or before the tenth day of the period, the Assistant to the General 
Manager will transmit a report to the Budget Committee showing a com- 
parison between the estimated manufacturing expenses for the past period 
and the actual costs as reported by the Accounting Department. If the 
Budget Committee desires to make any recommendations to the Produc- 
tion Department with reference to manufacturing expense during the re- 
mainder of the budget period, these recommendations will be communi- 
cated to the Works Manager through the Assistant to the General Manager 
on or before the twelfth day of the period. 

VI. The Materials Budget 
I . Estimate of Cost of Purchases 

The Works Manager will prepare an estimate of the materials required 
for each budget period. This estimate will be based on the estimate of 
production prepared by the Works Manager as outlined in Section III of 
this manual. The Works Manager will transmit the estimate of materials 
required to the Assistant to the General Manager on or before the tenth day 
preceding the beginning of the budget period. The Assistant to the Gen- 
eral Manager will transmit the estimate immediately to the General Pur- 
chasing Agent. On receipt of the estimate of raw materials requirements, 
the General Purchasing Agent will prepare an estimate of purchases to be 
made during the budget period. The General Purchasing Agent will make 
this estimate on the form supplied by the Assistant to the General Manager, 
which will contain the following columnar headings: 

(i) Item 

(2) First Period: 

(a) Estimated inventory at beginning of period 

(b) Estimated purchases 

(c) Estimated inventory at end of period 

(d) Estimated cash disbursements for purchases made during 

this period 

(e) Estimated cash disbursements for purchases made in pre- 

vious periods 



384 BUDGETARY CONTROL 

(3) Second Period: 

(a) Estimated inventory at beginning of period 

(b) Estimated purchases 

(c) Estimated inventory at end of period 

(d) Estimated cash disbursements for purchases made dur- 

ing this period 

(e) Estimated cash disbursements for purchases made during 

previous period 

(4) Third Period: 

(a) Estimated inventory at beginning of period 

(b) Estimated purchases 

(c) Estimated inventory at end of period 

(d) Estimated cash disbursements for purchases made during 

this period 

(e) Estimated cash disbursements for purchases made in 

previous periods 

The General Purchasing Agent will transmit this estimate to the Assist- 
ant to the General Manager on or before the last day of the second week 
preceding the beginning of the budget period. 

2. Approval By the Budget Committee 

The Assistant to the General Manager will at once transmit the esti- 
mate of purchases to the Budget Committee. The Budget Committee will 
make any changes it may deem necessary, and return the revised estimate 
withitsapproval to the Assistant to the General Manager within two days 
after its receipt by the Budget Committee. The Assistant to the General 
Manager will send the estimate of purchases as approved by the Budget 
Committee to the Purchasing Agent immediately upon its receipt from the 
Budget Committee. 

3. Periodic Report on Purchases 

At the end of each period, the Assistant to the General Manager will 
make a report to the Advisory Committee showing the actual purchases 
of the period compared with the estimated purchases and the actual inven- 
tory at the end of the period compared with the estimated inventory at the 
end of the period. 

This report will be submitted to the Budget Committee on or before the 
tenth day of the period. If the Budget Committee desires to make any 
changes in the purchases budget for the remainder of the budget period, 



MANUAL OF BUDGETARY PROCEDURE 385 

it will communicate its directions to the General Purchasing Agent through 
the Assistant to the General Manager on or before the twelfth day of the 
period. 

VII. Plant and Equipment Budget 

1. Estimate of Plant and Equipment Cost 

On or before the tenth day preceding the beginning of the budget period, 
the Works Manager will send to the Assistant to the General Manager an 
estimate of the expenditures for plant and equipment for each month in 
the next budget period. This estimate will be submitted on a form pre- 
pared by the Assistant to the General Manager. 

2. Approval by Budget Committee 

On or before the first day of the first week preceding the beginning of 
the budget period, the Assistant to the General Manager will transmit the 
estimate of plant and equipment expenditures as prepared by the Works 
Manager to the Budget Committee, with such recommendations as he may 
deem necessary. The Budget Committee will make such changes as it may 
deem expedient, and return the estimate with its applroval to the Assistant 
to the General Manager within two days after the receipt of the estimate 
by the Committee. The Assistant to the General Manager will immedi- 
ately transmit the estimate as approved by the Budget Committee to the 
Works Manager. 

3. Periodic Report on Plant and Equipment Expenditures 

On or before the eighth day of each period, the Accounting Depart- 
ment will send to the Assistant to the General Manager a report show- 
ing the expenditures for plant and equipment during the past period. 
The Assistant to the General Manager will supply the form for this 
report. 

On or before the tenth day of the period, the Assistant to the General 
Manager will transmit a report to the Budget Committee showing a com- 
parison between estimated plant and equipment expenditures for the past 
period and the actual expenditures as reported by the Accounting Depart- 
ment. If the Budget Committee desires to make any recommendations 
to the Production Department with reference to plant and equipment ex- 
penditures during the remainder of the budget period, these recom- 
mendations will be communicated to the Works Manager through 
the Assistant to the General Manager on or before the fifteenth day of 
the period. 

25 



386 BUDGETARY CONTROL 

4. Estimate of Furniture and Fixtures Required by General 

Offices 

On or before the fifteenth day preceding the beginning of the budget 
period, the head of each department will submit to the General Manager an 
estimate of expenditures for Furniture and Fixtures during the next budget 
period. The General Manager after consultation with the General Pur- 
chasing Agent will make such revisions as he deems necessary and transfer 
the estimate with his approval to the Assistant to the General Manager on 
or before the tenth day preceding the beginning of the budget period. 

5. Approval by the Budget Committee 

On or before the first day of the first week preceding the beginning of the 
budget period, the Assistant to the General Manager will transmit the esti- 
mate of furniture and fixtures as required by the general offices to the Budget 
Committee with such recommendations as he may deem necessary. The 
Budget Committee will make such changes as it may deem expedient and 
return the estimate with its approval to the Assistant to the General Man- 
ager within two days after its receipt by the Committee. 

The Assistant to the General Manager will return the estimate of furni- 
ture and fixtures to the heads of the various departments immediately upon 
its receipt by him from the Budget Committee. 

6. Periodic Report on Furniture and Fixtures 

On or before the tenth day of the period, the Assistant to the General 
Manager will transmit a report to the Budget Committee showing a com- 
parison between the estimated expenditures for furnitures and fixtures for 
the general offices for the past period and the actual expenditures as sub- 
mitted by the Accounting Department. If the Budget Committee desires 
to make any recommendations to the departmental heads with reference to 
furniture and fixture costs for the general offices for the remainder of the 
budget period, these recommendations will be communicated to the de- 
partmental heads through the Assistant to the General Manager. 

VIII. The Expense Budgets 

I . Control of Departmental Expense 

In order to provide an effective control of the expenses of the various 
departments, as well as to provide the necessary data for the quarterly 
cash budget, the following procedure is prescribed for all departments and 
executive units of the business: 



MANUAL OF BUDGETARY PROCEDURE 387 

(i) Before the beginning of each budget period, an estimate will be 
prepared by the executive head of each department or unit 
showing the anticipated expenses of this department or unit 
for the next budget period, and sent to the Assistant to the 
General Manager. 

(2) These estimates will be submitted by the Assistant to the Gen- 

eral Manager to the Budget Committee and after being re- 
vised by it where deemed necessary, an appropriation will be 
made to meet the expenses called for by each estimate. 

(3) The amount of the appropriations, as determined by the Budget 

Committee, will be communicated to the executive respon- 
sible for the original estimate by the Assistant to the General 
Manager. 

(4) A monthly report will be made to the Budget Committee 

through the Assistant to the General Manager, showing the 
status of each of these appropriations. 

(5) The original appropriation will not be exceeded without per- 

mission of the Budget Committee. 

2. Classification of Departments and Units 

For the purpose of expense control the various departments and units 
may be classified as follows: 

A. Administration 

(i) General Manager's Office 

(2) Credit Department 

(3) Purchasing Department 

(4) Accounting Department 

(5) Statistical Department 

(6) Stenographic Department 

(7) Personnel Department 

B. Selling 

(i) General Office 

(a) Office of the Sales Manager 

(b) Advertising and Sales Promotion 
(2) Direct Sales Units 

(a) Each Sales Office 

C. Production 

(i) Office of the Works Manager 

(2) Subsidiary Production Departments 



388 BUDGETARY CONTROL 

3. Procedure for the Preparation of Expense Budgets 

The procedure to be followed in the preparation and control of the ex- 
pense budgets of the various departments and executive units given in the 
foregoing outline will be as follows: 

Group A. Administration 
(i) Preparation of Estimate 

On or before the fifteenth day preceding the beginning of the budget 
period, the executive head of each of the departments listed under 
Group A will submit to the Assistant to the General Manager an 
estimate of the expenses of this department during the next budget 
period. The form to be used in the submission of the estimates will 
be provided by the Assistant to the General Manager and will con- 
tain the following columnar headings: 

(i) Department 

(2) Same period last year 

(3) Average for last four budget periods preceding the one dur- 

ing which the budget is prepared 

(4) Estimated cost for this period 

(5) Distribution: 

(a) First period 

(b) Second period 

(c) Third period 

Columns (2) and (3) will be filled in by the Assistant to the General 
Manager prior to sending the form to the executive head of each 
department. 

(2) Approval by the Budget Committee 
On or before the first day of the first week preceding the beginning of 
the budget period, the Assistant to the General Manager will submit 
the estimate of the expenses of the departments listed in Group A 
as prepared by the executive heads of the departments, to the Budget 
Committee with such recommendations as he may deem necessary. 
The Budget Committee will make such changes as it may deem 
necessary, and return the estimate with its approval to the Assistant 
to the General Manager within two days after the receipt of the 
estimate by the Committee. 



MANUAL OF BUDGETARY PROCEDURE 389 

The Assistant to the General Manager will return immediately the 
estimates as approved by the Budget Committee to the executive 
heads of departments listed under Group A. 

(3) Periodic Report 

On or before the eighth day of each period the Accounting Department 
will send to the Assistant to the General Manager a report showing 
the expenses for the past period for each of the departments listed 
under Group A. The Assistant to the General Manager will supply 
the form for the submission of this report. 

On or before the tenth day of the month, the Assistant to the General 
Manager will transmit a report to the Budget Committee showing 
the comparison between estimated expenses for each of the depart- 
ments under Group A for the past period and the actual expenses as 
submitted by the accounting department. If the Budget Com- 
mittee desires to make any recommendations to the executive heads 
of the departments with reference to their expenses during the re- 
mainder of the budget period, these recommendations will be com- 
municated to the executive heads through the Assistant to the 
General Manager. 

Group B. Sales 

(i) Preparation of Estimates 

On or before the tenth day preceding the beginning of the budget period, 
the Sales Manager will transmit to the Assistant to the General 
Manager an estimate of the expenses of his department including: 

(a) The expenses of himself and staff 

(b) The expenses of the direct selling units 

(c) The expenses of the advertising and sales promotion depart- 

ment 

This estimate will be submitted on a form provided by the Assistant to 
the General Manager. 

(2) Approval by the Budget Committee 

On or before the first day of the first week preceding the beginning of 
the budget period, the Assistant to the General Manager will sub- 
mit the estimate of the expenses of the departments listed under 
Group B as prepared by the Sales Manager, to the Budget Com- 
mittee with such recommendations as he may deem necessary. The 



390 BUDGETARY CONTROL 

Budget Committee will make such changes as it may deem neces- 
sary and return the estimate with its approval to the Assistant to the 
General Manager within two days after the receipt of the estimate 
by the Committee. 
The Assistant to the General Manager will return immediately the esti- 
mates as approved by the Budget Committee, to the Sales Manager. 

(3) Periodic Report 

On or before the eighth day of each period the Accounting Department 
will send to the Assistant to the General Manager a report showing 
the expenses for the past period for each of the divisions of the de- 
partment listed under Group B. The Assistant to the General 
Manager will supply the form for the submission of this report. 

On or before the tenth day of the period the Assistant to the General 
Manager will transmit a report to the Budget Committee showing 
the comparison between estimated expenses for each of the depart- 
ments under Group B for the past period and the actual expenses as 
submitted by the Accounting Department. If the Budget Com- 
mittee desires to make any recommendations to the Sales Manager 
with reference to the expenses of his department during the re- 
mainder of the budget period, these recommendations will be com- 
municated to the Sales Manager through the Assistant to the Gen- 
eral Manager. 

Group C. Production 

(i) Preparation of Estimate 

On or before the tenth day preceding the beginning of the budget period, 
the Works Manager will submit to the Assistant to the General 
Manager an estimate of the expenses of his department. The ex- 
penses shown on this estimate will be exclusive of the expenses shown 
on the estimate of manufacturing expenses prepared as directed 
under Section V. This estimate will be submitted on a form pro- 
vided by the Assistant to the General Manager. 

(2) Approval by the Budget Committee 

Oh or before the first day of the week preceding the beginning of the 
budget period, the Assistant to the General Manager will submit 
the estimate of the expenses of the Production Department as pre- 
pared by the Works Manager, to the Budget Committee with such 
recommendations as he may deem necessary. The Budget Com- 



MANUAL OF BUDGETARY PROCEDURE 39I 

mittee will make such changes as it may deem necessary and return 
the estimate with its approval to the Assistant to the General Man- 
ager within two days after the receipt of the estimate by the Com- 
mittee. 
The Assistant to the General Manager will return immediately the esti- 
mate as approved by the Budget Committee to the Works Manager. 

(3) Periodic Report 

On or before the eighth day of each period, the Accounting Department 
will send to the Assistant to the General Manager a report showing 
the expenses for the past period of the Production Department. The 
Assistant to the General Manager will supply the form for the sub- 
mission of this report. 

On or before the tenth day of the month, the Assistant to the General 
Manager will transmit a report to the Budget Committee showing 
the comparison between estimated expense for the Production De- 
partment for the past period and the actual expenses as submitted 
by the Accounting Department. If the Budget Committee desires 
to make any recommendations to the Works Manager with refer- 
ence to the expenses of his department during the remainder of the 
budget period, these recommendations will be communicated to 
the Works Manager through the Assistant to the General Manager. 

IX. The Financial Budget 

I. Preliminary Estimates of Cash Receipts and Cash Disburse- 
ments 

The Assistant to the General Manager, working in conjunction with 
the Assistant Treasurer, will prepare a preliminary estimate of cash receipts 
and a preliminary estimate of cash disbursements for each budget period 
based on the following: 

(i) The estimates submitted by the various departments. 

(2) An estimate of the disbursements for taxes, insurance, and 

other items which are under the control of the Assistant 
Treasurer. 

(3) Estimate of the collections from accounts receivable outstand- 

ing at the beginning of the period. 

(4) Estimate of the disbursements on accounts payable outstanding 

at the beginning of the period. 



392 BUDGETARY CONTROL 

The Assistant to the General Manager will transmit these preliminary 
estimates of cash receipts and cash disbursements to the Budget Committee 
on or before the first day of the first week preceding the beginning of the 
budget period. This will enable the Budget Committee to consider the 
financial requirements of the various estimates submitted to it. 

2. Revision of Preliminary Estimates 

After the departmental estimates have been approved by the Budget 
Committee, the Assistant to the General Manager will revise the prelimi- 
nary estimates of cash receipts and cash disbursements giving effect to the 
revisions in the departmental estimate which were made by the Budget 
Committee. The revised estimates will be submitted to the Treasurer on 
or before the third day preceding the beginning of the budget period. 

3. Periodic Reports 

Periodic reports will be submitted to the Budget Committee showing a 
comparison between estimated receipts and actual receipts and estimated 
disbursements and actual disbursements. If the Budget Committee desires 
to revise other budgets because of the financial condition, these revisions 
will be submitted to the departments concerned by the Assistant to the 
General Manager. The revisions made in the financial budget will be 
communicated to the Treasurer. 

X. Preliminary Estimated Financial Statements 

1 . Preliminary Estimates of Financial Condition and Results of 

Operation 

The Assistant to the General Manager will prepare from the departmen- 
tal budgets an estimated balance sheet showing the estimated financial 
condition at the end of each accounting period during the budget period. 
He will also prepare in the same manner an estimated statement of profit 
and loss showing the anticipated results of the operations for each period. 

The Assistant to the General Manager will transmit these preliminary 
estimates to the Budget Committee on or before the first day of the first 
week preceding the beginning of the budget period. This will enable the 
Budget Committee to consider these at the same time that it is considering 
the departmental estimates. 

2. Revision of Preliminary Estimates 

After the departmental estimates have been approved by the Budget 
Committee, the Assistant to the General Manager will revise the prelimi- 



MANUAL OF BUDGETARY PROCEDURE 393 

nary estimated financial statements giving effect to the changes made by the 
committee in the departmental estimates. 

3. Periodic Reports 

Periodic reports will be submitted to the Budget Committee by the 
Assistant to the General Manager, showing a comparison between the 
actual and the estimated financial statements. These reports will be sub- 
mitted at the same time as the other budgetary reports. 

Comments on Manual — Manual Confined to Interdepartmental 
Procedure 

It will be noticed that the manual is confined to the pro- 
cedure involved in the interdepartmental relations arising 
from the budgetary program. It does not outline in detail 
the procedure to be followed by each department in the 
preparation of its estimate or the carrying out of its 
budget. Since the manual is to be placed in the hands 
of all of the executives, it is not thought worth while to 
encumber it with the detail of departmental procedures. 
It is thought better that these be issued as departmental 
orders. 

Central Control of Estimates 

It is important to notice that the manual requires the 
estimates of all departments to be submitted to the budget 
committee at one time (on or before the first day of the first 
week preceding the beginning of the budget period) ; the 
consideration and approval of these estimates within two 
days after their receipt ; and the return of the approved esti- 
mates to the departmental heads immediately upon their 
approval. 

This enables the budget committee to have before it, at 
one time, the estimates of all the departments and units of 
the company, and provides a central control of all the ac- 
tivities of the business. The monthly reports which are to 



394 BUDGETARY CONTROL 

be submitted to the budget committee provide a means of 
control over the execution of the budgets. 

Authority of Budget Committee 

It will be noted that the budget committee is given au- 
thority to pass on estimates. Although the manual does 
not so state, the financial budget and the estimated balance 
sheet and statement of profit and loss are submitted to the 
board of directors at the beginning of each budget period. 

Dates for Submission of Estimates and Reports 

It will be noticed that particular attention is given to the 
dates on which reports and estimates are submitted. This 
is especially important, as otherwise there will be a lack of 
coordination in the budgetary procedure. For instance, the 
production department cannot prepare the finished goods 
estimate until it receives the sales estimate; the purchasing 
department cannot prepare the estimate of purchases until 
it receives the estimate of materials requirements; and the 
assistant to the general manager cannot prepare the 
estimated financial statements until he receives all the esti- 
mates. These illustrations show that if one department is 
tardy in the preparation of its estimate or report, the entire 
program is delayed as a consequence. 

Chart of Budget Procedure 

A manual prepared in the form of the foregoing example 
contains a considerable amount of detail and it is some- 
what difficult to obtain a comprehensive view of the pro- 
cedure as a whole. 

A chart prepared in the form shown in Figure 43, enables 
the executives to see the relationship between the various 
budgets and the duties of each executive with reference to 
each budget. '^ 





SALES 
BUDGET 


PRODUCTION 
BUDGET 


A. SALES MANAGER 


1. Anticipated sales for budget 
period, by grade and put-up, to E 
on or before 1st day of the 3rd 
week pceced^g budget period. 

2. Receive approved Sales Bud- 
get from E. 

3. Receive revised Sales Budget 
from E on or before 15tli day after 
close of period. 




B. WORKS MANAGER 


1. Receive copy of sales esti- 
mate from E on or before 3rd day 
of 3rd week preceding budget 
period. 


1. Transmit estimate of produc- 
tion to E on or before 3rd day o] 
2nd week preceding budget period 

2. Receive approved Produc- 
tion Budget from E. 

3. Report of production to I 
on or before 5th working day aftei 
close of period. 

4. Receive revised Productior 
Budget from E. 


C.. GENERAL MANAGER 






D. BUDGET COMMITTEE 


1. Revise and approve within 
2 days after receipt from E — 
return to E. 

2. Receive comparison of esti- 
mated and actual sales from E — 
report any revisions in Sales Bud- 
get to E on or before 15th day 
after close of period. 


1. Revise and approve withir 
2 days after receipt from E— 
return to E. 

2. Receive comparison of esti- 
mated and actual production fron 
E — report any revisions in Pro- 
duction Budget to E on or before 
12th day after close of period. 


E. ASSISTANT TO THE 
GENERAL MANAGER 


1. Submit copy of anticipated 
sales to B within 2 days after 
receipt from A. 

2. Original estimate to D on or 
before the 1st day of 1st week 
preceding budget period. 

3. Receive approved Sales Bud- 
get from D and transmit to A. 

4. Comparison of estimated and 
actual sales together with recom- 
mendations to D on or before 10th 
day after close of period. 

5. Transmit revision in Sales 
Budget CO A on or before 15th day 
after close of period. 


1. Receive and transmit esti- 
mate of production to D on oi 
before 1st day of 1st week preced- 
ing budget period. 

2. Receive approved Produc- 
tion Budget from D and transmii 
to B. 

3. Comparison of estimated anc 
actual production to D on oi 
before 10th day after close ol 
period. 

4. Transmit revisions in Pro- 
duction Budget to B on or before 
15th day after close of period. 


F. STATISTICAL DEPT. 


1. Report of actual sales for the 
period to E on or before the 5th 
working day after close of period. 




G. ACCOUNTING DEPT. 






H. PURCHASING AGENT 









SALES 
BUDGET 


PRODUCTION 

BUDGET 


PAY-ROLL 
BUDGET 


STORES PURCHASE 
BUDGET 


MATERIAL 
BUDGET 


PLANT AND EQUIP- 
MENT BUDGET 

btf.ifo i.ith day after cIobo of 


MISCELLANEOUS 
EXPENSE BUDGET 


FINANCIAL 
BUDGET 


A. SALES MANAGER 


1. ;\iiticii)ated sales for budget 

week pnccccyjig budget period. 

2. Hcccivo approved Sales Bud- 
get from B. 

3. Keceive revised Sales Budget 
from E oQ or before 15th day after 




pay-roll to E on or before lOth day 
precedhig budget period. 

2. Receive approved Pay-roll 
Budget from E. 

3. Receive revised Pay-roll Bud- 
after close of period. 






'"'■'"ii-vn. .>,; 1 \li^.;aia- 

porlod. 




B. WORKS MANAGER 


1. Receive copy of sales esti- 
mate from E on or before 3rd day 
of 3rd wccl: preceding budget 

lieriod- 


1. Transmit estimate of produc- 
tion to E on or before 3rd day of 
2ud week preceding budget period. 

2. Receive approved Produc- 
tion Budget from E. 

3. Report of production to K 

close of period. 

4. Receive revised i'roduction 
Budget from E. 


1. Estimate of the factory pay- 
roll to E on or before 10th day priv 
coding budget period. 

2. Receive approved Pay-roll 
Budget from E. 

3. Receivorevlsed Pay-roll Bud- 
get from B on or before 15ih day 
after close of period. 


1. Estimate of stores pur- 
preceding budget period. 

2. Receiveapprove<i StoresPur- 
chase Budget from E. 

3. Receive revised Stores Pur- 
chase Buget from E on or before 
15th day after close o' period. 


quired to E on or before lOth day 
preceding budget period. 


3. See Salbb Manaqkil 


3. See Sales ManaqbrI 




C.. GENERAL MANAGER 






1. Estimated administrative 
pay-roU to E on or before lOth day 
preceding budget period. 

2. Receive approved Pay-roU 
Budget from E. 

3. Recelvorevisod Pay-rollBud- 
get from E on or before 15th day 
after close of period. 






mates of expenditures for plant 

lx'1'iirt.j luMi day prw-i.-ding budget 

Kil^uipmout Builget lYom E on or 
biiuro I5th day after close of 


1. Soo SAI.BH Mana^ibk. 
X Sw Iales ManaokII; 


1. Roviw and ajiprovo ustlmato 
of cfl.sli reeolptw and dlsbUTSo- 

2. Receive Financial Budgot. 


D. BUDGET COMMITTEE 


1. Revise and approve \vithiii 
2 days after receipt from E — 

2. Receive comparison of esti- 

get to E on or before lath day 
after close of period. 


2 days after roceu>t from E — 

mated and actual producti9n from 

duction Budget to E on or before 
12th day after close of period. 


1. Rsvise and approve within 
2 days after receipt from E — 

2. Receive comparison of esti- 

roll Budget to E on or before 12th 
day after close of period. 


1. Revise and approve within 

2. Receive comparison of esti- 
mated and actual stores pur- 
chases from E — report any reW- 
sions hi Stores Purchase Budget 
to E on or before 12th day after 
close of period. 


1. Revise and approve within 2 
daw after receipt from E — reiiirn 

2. Receive comparison of i^ii- 

slons in Material Budgei^ti'i K Mi 
or before I2th day after clu^o .if 
period. 


jl;':' ^^^.,i/:■;^fl'';:; 


I. Revise and approve within 2 
daj-s after ntvlpt from E— return 


1. RuvUo and roturn within 2 
days atter receipt from K. 

2. Reculvu comuarUon of wtl- 
inatod and actual ca-ih receipts 

revisions lu Flnimclol Budget 


E. ASSISTANT TO THE 
GENERAL MANAGER 


1. Submit copy of anticipated 
sales to B within 2 days after 

2. Original estimato to D on or 
before tho lat day of 1st week 
preceding budget period. 

get from D and transmit to A. 

4. Comparison of estimated and 
actual sales together with recom- 
mendations to D on or before 10th 
day after close of period. 

Budget to A on or before 15th day 
after close of period. 


1. Receive and transmit esti-< 
mate of production to D on or 
before 1st day of 1st week preced- 
ing budget period. 

2. Receive approved Produc- 
tion Budget from D and transmit 

3. Comparison of estimated and 
actual production to D on or 
before 10th day after close ot 

4. Transmit revisions in Pro- 
duction Budget to B on or befoni 
15th day after close of period. 


1st day of 1st week preceding 
budget period. 

2. Receive approved Pay-roll 
Budget from D and transmit to 
A. B, and C. 

3. Comparison of estimated and 
actual pay-roll to D on or before 
10th day after close of period. 

4. Transmit revisions m Pay- 
roll Budget to A, B. and C on or 

period. 


mated stores purchases to D on or 
before 1st day of lat week preced- 
ing budget period. 

2. Receive approved Stores Pur- 
chase Budget from D and transmit 

3. Comparison of estimated and 
actual stores purchases to D on or 

period. 

4. Transmit revision of Stores 
Purchase Budget to B on or 
before 15th day after close of 
period. 


mated material requirements to U 
on or before 10th day pri'cediiig 
budget period. 

ceding budget period. 


1. Uvceive approved estimates 
of i-xpendiULiM for plant anil 


1. Ri<:olvo and tnuismlt ostl- 


t. Prepare ostlmato of cajth 
riTclpf una dlsbursonu'nts — suh- 

'" ' '"'" '"III day after 


F. STATISTICAL DEPT. 


1. Report of actual sales for the 
working day after clo.se of period. 
















G. ACCOUNTING DEPT. 






1. Report of actual pay-roll to 
E on or before 8th day after close 
of period. 


1. lieport of actual stores pur- 
chases to E on or before Sth day 
after close of period. 


1. Report of actual material 
purchases to E on or before Sth 
day after close of period. 


1- Reiiuit actual ©X|)ondltures 
Kplaut and eciuipment to 15 on or 
pbro Sth day after close of i>erlod. 


1. Report actual miHcullanoous 
oxponso to E on or before sth day 
after clo-so of pej-lod. 




H, PURCHASING AGENT 










fVr;: '■.".;"■' ."".","■;.■-.;,:: 










- 




FIGURE 43 


CHART OF BUDGET PROCEDURE 

1 







MANUAL OF BUDGETARY PROCEDURE 395 

The chart is prepared from the manual given in this 
chapter with a few modifications. It will be noticed that 
the chart calls for a ''stores purchased" budget and a "mis- 
cellaneous expense" budget, instead of a manufacturing ex- 
pense budget and departmental expense budgets. It also 
omits the procedure for the preparation of the estimated 
financial statements. 



CHAPTER XXIV 
ADMINISTRATIVE REPORTS 

Need for Administrative Reports 

The previous chapters have emphasized the need for the 
collection of data to serve 

1. As the basis of formulating plans of operation, and 

2. As the basis of enforcing plans which have been adopted. 

This information is most serviceable when it is presented in 
a summarized and classified form by means of properly de- 
signed reports. 

Reports should be used by all the executives and em- 
ployees of a business. We usually think of reports in con- 
nection with the general officers, for their actions are based 
largely on reports and the reports which they receive are of a 
formal nature. Nevertheless, all employees except those 
engaged in routine manual tasks are receiving reports daily. 
These reports may come to them as business forms on which 
they perform certain tasks and then transmit them to others. 
They are nevertheless reports in the sense in which that 
term is used in this discussion. 

Classification of Administrative Reports 

The reports used in administrative control may be clas- 
sified broadly into the following groups : 

I. Reports showing present financial condition. The standard 
form of balance sheet with its various subsidiary schedules 
is used for this purpose. This is the oldest and most widely 
used of administrative reports. The reasons for its origin 
and extensive use have been explained in a preceding chapter. 

396 



ADMINISTRATIVE REPORTS 397 

2. Reports showing the results of past operations in terms of ex- 

pense and income. The various forms of expense and income 
' analyses, and the standard form of statement of profit and 
loss, with subsidiary schedules, are used for this purpose. Next 
to the standard form of balance sheet, these are the reports 
most widely used. For internal control they are used more 
widely than the balance sheet and are decidedly more 
serviceable. 

3. Reports showing pertinent information which is necessary for the 

daily actions of executives and employees. These reports may 
consist of a statement for the treasurer, showing the accounts 
payable falling due on a current day ; of a report to the collec- 
tion manager, showing accounts thirty, sixty, and ninety days 
past due ; of a report to the sales manager, showing the slow- 
moving items of stock ; and various other reports of a similar 
nature. These reports are not so widely discussed as the 
standard financial statements, yet they serve a very vital 
function in the internal administration of a business. 

4. Reports showing anticipated results of future operations. These 

reports include estimates of sales, estimates of purchases, 
estimates of production, estimates of financial condition, esti- 
mates of income, expense, and net profit, and similar reports. 
These estimates serve as a basis for future plans in the manner 
explained in preceding chapters. 

5. Reports showing a comparison between the actual performance 

and the estimated or standard performance. Such reports 
make possible the enforcement of budgets and provide data 
which serve as a means of revising the budgets when this is 
found necessary. 

Essentials of Executive Reports 

In the foregoing discussion administrative reports have 
been defined broadly to include the reports used by all the 
executives and employees of a business. But in every busi- 
ness it is desirable to prepare some formal reports for the 
use of the principal executives only. In contradistinction 
to the broad group of administrative reports, these may be 
termed "executive" reports. During the remainder of this 



398 BUDGETARY CONTROL 

chapter we shall be concerned primarily with the latter 
group, although most of the discussion is equally applicable 
to the general group. 

Since executive reports are intended to serve as a basis 
for the formulating of executive decisions, which in turn 
result in executive actions, it is expedient that they be made 
so as to present accurate and comprehensive information 
and to present it in such form that correct judgments can 
be formed with as little sacrifice of effort as possible. If this 
end is to be attained, executive reports must have the fol- 
lowing characteristics : 

First, they should present summarized information. 
Details should be eliminated as much as possible. Each 
report should show a few essential items of information. 
They should be constructed so as to show variations between 
the standard performance and the actual performance. In 
case of significant variations, the executive should receive an 
explanation of the cause from the controller or some other 
official designated for this purpose. If the executive re- 
ceives a few condensed reports he will be able to study care- 
fully each report. Details are of value only to explain 
variations. Many details serve only to confuse. 

Second, executive reports should show the following: 

1. Actual performance for the current period. 

2. Comparison of the performance of the current period with the 

estimated or standard performance for the period. 

3. Comparison of the current performance with the performance of 

past periods. 

4. Comparison of the current performance with the results of the 

performance. 

Actual Performance 

Each executive should know at frequent intervals what 
the performance has been of his own department and of each 
of the other departments the activities of which affect the 



ADMINISTRATIVE REPORTS 399 

activities of his own department. Reports presenting in- 
formation of this kind have long been in use and Httle more 
need be said here with reference to them than to emphasize 
the following: 

1 . That care must be taken that these reports be made accurately. 

2. That they be sufficiently comprehensive to serve as a basis for 

proper action. 

3. That they should be made promptly. 

4. That they are more effective if modified so as to include the 

comparisons indicated by the following discussion. 

Estimated Performance 

Most if not all executives will admit the need of a state- 
ment of the current performance, but many do not realize 
the importance of establishing estimates of performance 
and comparing the actual with the estimated. The dis- 
cussion in the preceding chapters has emphasized the im- 
portance of preparing budgets and using them as control 
devices. The reports which are used in preparing and con- 
trolling these budgets have been discussed in connection 
with each of them. In addition to these reports it is de- 
sirable that the effect of the budgetary program should 
be shown on all the executive reports. This can be done 
most easily by designing these reports so that they will show 
a comparison between the estimated and the actual per- 
formance. 

By way of emphasis it is worth while to state the follow- 
ing benefits to be derived from the establishment of the 
estimates : 

1 . In order to make the estimates it will be necessary for 
the executives responsible for them to study past perform- 
ance and to consider future possibilities. This study will 
undoubtedly increase the efficiency of these executives. 

2. The estimates will set up a goal for attainment. They 
will constitute a "bogie" which the executives will try to 



400 BUDGETARY CONTROL 

attain. A comparison between the actual and the estimated 
will provide a check on the activities of the executives and 
will serve as an incentive towards the attainment of the 
estimated. 

3. A study and comparison of the estimates will make 
possible a better coordination of the activities of the various 
functional departments, since each department can deter- 
mine from the estimates the plans of other departments and 
guide its activities accordingly. 

4. The preparation and use of the estimates will make 
possible the elimination of much detail in the reports to the 
executives. Details instead of being presented for the con- 
sideration of the executives each month, will be presented 
in the original estimates when they are presented for execu- 
tive approval. After the estimates have been considered 
and approved, it will not be necessary for the executive to 
receive detailed reports during the period covered by the 
estimates. If he receives a summary report which shows a 
comparison between the results attained and the estimate, 
it will be sufficient. Executives should consider details with 
reference to operations before the operations take place rather 
than after they are performed. Of course, if variations be- 
tween the estimated and the actual are shown by the reports, 
they may ask for sufficient detail to explain the changes. 

Past Performance 

Although past performance alone is not a satisfactory 
standard by which to judge current performance, a com- 
parison between current performance and past performance 
is very useful in that it shows whether the tendency is desira- 
ble or undesirable. If statistics with reference to past per- 
formance and current performance are compiled by means 
of reports for a considerable number of periods, very useful 
data will be available for use in making future estimates. 



ADMINISTRATIVE REPORTS 401 

Results of Performance 

Whenever possible, a comparison should be made be- 
tween performance and results. For instance, selling ex- 
pense may be compared with sales; gross profits and net 
profits with sales; volume of production with cost of pro- 
duction; and various other comparisons which will occur to 
the reader. These comparisons should be shown not only 
for the current period but also for past periods, so that 
tendencies may be easily seen. Comparisons of this nature 
make it possible to obtain a true perspective of results. 
Obviously increased sales are desired only when increased 
profits will result. 

Illustration of Reports 

It is obviously impossible to discuss and illustrate all 
the various reports which may be used in executive control. 
These will vary in number and form from business to busi- 
ness. 

Some of these reports have been illustrated in previous 
chapters. For instance, in Chapters XXI and XXII the 
estimated balance sheet and estimated statement of profit 
and loss with the proper comparisons were illustrated. In 
earlier chapters reports showing a comparison between the 
actual and estimated performance were shown. 

In the present discussion it is thought sufficient to illus- 
trate a few of the reports which may be used in sales and 
production control. Using these as types and applying the 
the general principles given in the foregoing discussion, the 
reader should be able to design reports to fit any particular 
needs. 

Sales Reports 

The reports which may be used in sales control are too 
numerous to mention. They will vary greatly from busi- 

26 



402 



BUDGETARY CONTROL 



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404 BUDGETARY CONTROL 

ness to business depending on the volume of sales, nature of 
product sold, and method of marketing. But it is thought 
that in every business the principal executives of the busi- 
ness should have reports which show the following : 

1 . Volume of sales 

2. Selling expenses 

3. Net profits 

4. Inventory of finished goods 

Typical reports for each of these will be illustrated. 

Monthly Report on Volume of Sales 

If a business markets its product through branches or 
divisions, this report will show the total sales of each selling 
unit for the current period compared with the estimated 
sales and the sales of previous periods. If the sales are all 
made from a central office, it may show the same compari- 
sons for sales territories, or it may show the sales classified 
by groups, departments, or products. In any case the com- 
parisons should be the same. 

A typical form for this report is shown in Figure 44. 
This report is designed for the use of a manufacturing com- 
pany marketing its product partly through division sales 
offices and partly through sales branches. This report 
shows useful comparisons for each selling unit and in addi- 
tion provides a means of comparing the results attained by 
the different units. 

Monthly Report on Selling Expenses 

If a business markets its product through divisions or 
branches, a monthly report should be made to show the 
total selling expense of each selling unit with a comparison 
of this expense with the sales obtained. If the sales are 
made from a central sales department, this report may show 
the same comparisons by territories. If selling expenses 



ADMINISTRATIVE REPORTS 



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406 BUDGETARY CONTROL 

are allocated to lines of product, the report may be made to 
show the result of this allocation. In a department store it 
may show sales and expenses by departments. In this 
latter case judgment must be used in interpreting the re- 
port, for it is to be expected that the ratio of expense to sales 
will vary between departments which sell different kinds 
of goods. 

A typical form for this report is shown in Figure 45. 
The report provides a means of: 

1 . Checking actual expenses against estimated expenses. 

2. Comparing the ratio of expenses to sales during the current and 

past periods. This comparison is of especial importance, as 
increases and decreases in selling expenses are of significance 
only in comparison with the results obtained. 

3. Comparing the ratio of expenses to sales in different selling units. 

This comparison is significant in judging the efficiency of 
branch executives. 

Monthly Report on Net Profits 

This report may show net profits of selling units, terri- 
tories, departments, or by lines of goods. In a business 
marketing its product through branches or division ofhces, 
it shows the net profits made by each selling unit and 
the ratio of net profits to sales with the proper com- 
parisons. 

A typical form for this report is shown in Figure 46. 
This report affords a means of: 

1. Checking actual net profits against estimated net profits. 

2. Comparing the ratio of net profits to sales during the current 

year with the same ratio for the past year. This comparison 
is a very important one, since it is not an increase of sales, but 
an increase of profits that is the goal. 

3. Comparing the ratio of profits to sales in different selling units. 

This comparison is important in judging the efficiency of 
the management of the various units. 



ADMINISTRATIVE REPORTS 



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410 BUDGETARY CONTROL 

Monthly Stock Report 

This report should show the total inventory in stock 
classified according to the major groups maintained for 
sales and inventory. It should show the comparisons indi- 
cated by form in Figure 47. 

It is desirable that a standard or estimated inventory be 
determined which can be used as a means of judging the size 
of the inventory on hand. It is important that careful 
consideration be given to turnover figures; so it is well to 
have them shown on the periodical reports. If the turn- 
over for each quarter is shown this should be sufficient. 

Production Reports 

The reports which raay be used in production control 
are too numerous to mention. They will vary greatly from 
business to business, depending on the volume of production, 
the nature of the production process, and the organization 
by which the production is carried on. But it is thought 
that in every business the executives should have reports 
which show the following : 

1. Summary of Orders Recei\;ed, Shipments, Production, and 

Shortage or Surplus 

2. Summary of Operations 

3. Unit Costs 

4. Factory Inventories 

Monthly Summary of Orders Received, Shipments, Production, 
and Shortage or Surplus 

This report shows the orders received, the shipments, 
the production and the unfilled orders for the current period 
and for past periods, in such form that comparisons can 
be easily made. Each of these items will be classified 
according to the major groupings maintained for sales, 
production, and inventory. It is preferable that it be 



ADMINISTRATIVE REPORTS 411 

made in terms of physical units rather than in terms 
of value. 

A typical form for this report is shown in Figure 48. As 
indicated by the illustration, totals are shown at the bot- 
tom of the form so that the totals of the groups can be com- 
pared. If a company has two or more factories a separate 
report will be made for each factory. 

If desired, a separate report can be prepared for each of 
the items which appear on the combined report, that is, 
orders received, shipments, production, and unfilled orders. 
Each of these reports should show the following compari- 
sons: 

1 . Group (name or number) 

2. This month 

3. Estimated this month 

4. Per cent of increase or decrease 

5. Last month 

6. Per cent of increase or decrease 

7. Same month last year 

8. Per cent of increase or decrease 

9. Total to date this year 

10. Total to date last year 

1 1 . Per cent of increase or decrease 

The additional information which these subsidiary reports 
provide is evident. 

Monthly Summary of Operations 

It is desirable that both the production and other execu- 
tives of the company should have a comprehensive picture 
of the factory operations for each period. A possible form 
for a report which will provide this is shown in Figure 49. 
The purpose of the data shown in this report is apparent. 

In some cases the classification of cost elements shown in 
the first column will need to be changed. It can be made to 
suit the needs of each case. 



412 



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ADMINISTRATIVE REPORTS 415 

Monthly Report on Unit Costs 

This report shows the volume of production as well as 
the unit costs. The volume of production is significant in 
comparing unit costs, since the quantity produced may 
affect the unit costs. 

A typical form for this report is shown in Figure 50. In 
the illustration the volume of production is stated in terms 
of tons, and pounds are used as the basis of stating unit costs. 
In many businesses it would be necessary to use other units 
for both of these. 

Monthly Report on Factory Inventories 

This report shows the total inventories carried at the 
factory with appropriate comparisons. The classification 
of inventory will depend on the nature of the product manu- 
factured, but should always indicate clearly the inventories 
of (i) raw materials, (2) work in process, and (3) finished 
goods. It should also show plant and equipment in process 
as a separate item. It is preferable that both the physical 
amount and the value of the inventories be stated. 

A possible form of this report is shown in Figure 51. 

Varied Kind of Reports 

It is desired to emphasize once more that the few reports 
illustrated in this chapter are intended to be suggestive only. 
These few are given primarily for the purpose of showing 
concretely the application of the principles discussed in the 
first part of this chapter. The reports needed for any par- 
ticular business can be designed only after a careful study 
of its operations and of its organization and administrative 
methods. 



CHAPTER XXV 

ADVANTAGES AND LIMITATIONS OF BUDGET- 
ARY CONTROL 

Advantages of Budgetary Control 

Why Discussion Is Postponed 

In most texts on accounting, cost accounting, auditing, 
and similar subjects, the authors explain at the beginning of 
their texts the advantages to be derived from the applica- 
tion of the methods which they are to discuss. This un- 
doubtedly is good propaganda, but it is the author's impres- 
sion that the reader can better understand the advantages 
of any administrative procedure or device after he under- 
stands its nature and its method of operation. Conse- 
quently, he has deemed it expedient to postpone the discus- 
sion of the advantages of budgetary control until the end of 
the text. The advantages which are thought to be most 
significant will now be discussed. 

Coordination of Sales and Production 

Goods can be sold only when produced, and they should 
be produced only when they can be sold. To obtain sales 
orders which cannot be filled leads to loss in several ways, of 
which the following are the most apparent : 

1 . It causes the incurrence of unnecessary expenses in getting orders 

which cannot be filled. 

2. It causes the expense of recording the orders when received. 

3. It causes the expense of answering the inevitable complaints of 

the customers who fail to receive the goods when promised. 

416 



ADVANTAGES AND LIMITATIONS 417 

4. It causes the expense of reversing the entries made for the order 

when the customer finally cancels it. 

5. It incurs the ill-will of the customer, which may result in the 

loss of his trade in the future when it may be needed. 

On the other hand^ the production of goods in excess of 
sales orders leads to even more undesirable results, of which 
the following are the most important : 

1. It ties up capital in unsalable goods, with the consequent cost 

incurred in securing the capital. 

2. It ties up capital which may be needed badly in carrying on other 

operations, and in some cases the loss of the use of this capital 
may result in serious financial embarrassments. 

3. It results in the procurement of goods which may physically de- 

teriorate or become obsolete before they can be sold. 

If a sales estimate is prepared, and this estimate is 
approved by the production department and used as a basis 
of its program, these difficulties can in the main be elimi- 
nated. Any disagreement between the sales and production 
departments is settled by the budget committee, which is 
qualified to render impartial judgment. 

What is said here with reference to the coordination of 
sales and production in a manufacturing business, applies 
equally to the coordination of sales and purchases in a mer- 
cantile business. 

Formulation of a Profitable Sales and Production Program 

The sales department does not always desire to sell the 
goods which can be produced to the best advantage, and 
the production department does not always prefer to pro- 
duce the goods for which there is the most ready and prof- 
itable market. If left to itself each department will follow 
the line of least resistance. 

There has long been an argument as to whether the sales 
or production department should exercise the greater influ- 

27 



41 8 BUDGETARY CONTROL 

ence in deciding the commodities which a business produces 
and offers for sale. Production executives often contend 
that the production department should decide what it is best 
equipped to produce and that the sales department should 
then be instructed to find a market for these products. On 
the other hand, sales executives often contend that it is the 
function of the production department to serve the sales 
department and to produce the goods which the latter can 
sell. 

A little consideration will show that neither of these 
views is correct. It is the function of each of these depart- 
ments to serve the business as a whole to the end that as 
much profit as possible may be made. The hundred of idle 
factories in the country even in normal times is a testimonial 
to the fallacy of attempting to produce without a proper 
consideration of the market, and the many discarded ma- 
chines of factories still operating, as well as the hundreds of 
items sold at a loss, is evidence of the impropriety of trying 
to change the production program to meet the passing 
whims of the sales department. 

A proper coordination of sales and production, not only 
from the viewpoint of quantity, but also from the viewpoint 
of profit, is essential. The production equipment should 
be as flexible as possible so that changes can be made to 
meet market conditions, but a certain amount of standard- 
ization is essential to well-regulated production, and the 
sales department by proper effort can do much to in- 
crease the sales of those lines which can be produced most 
efficiently. 

Although it is usually convenient for the sales depart- 
ment to take the first step in the budgetary process, the 
sales estimate must be gone over from the viewpoint of the 
production possibilities, profit potentialities, and financial 
requirements. 



ADVANTAGES AND LIMITATIONS 419 

Coordination of Sales and Production Programs with Finances 

No sales and production program, regardless of its 
profit potentialities, is desirable if its financial requirements 
cannot be met by the particular firm under consideration. 
It is necessary that careful consideration be given to the 
financial requirements of all plans contemplated. As stated 
in Chapter II, a lack of coordination between sales and pro- 
duction will lead to a loss, but a lack of coordination between 
sales, production, and finance will lead to bankruptcy. 

It must be remembered, however, that the capital pos- 
sibilities of a firm may be materially affected by the length 
of time which is available for planning to meet require- 
ments. If the financial requirements of the contemplated 
program are known for a sufficient length of time prior to its 
initiation, capital may be secured which would not be obtain- 
able on short notice. 

The budgetary program, therefore, is especially signifi- 
cant in financial planning and financial planning is the 
essence of financial administration. 

Proper Control of Expenses 

A proper control of expenses is necessary to profitable 
operations. The purchase and sales prices of commodities 
are usually determined largely by competition. The dif- 
ference between the expenses incurred and the gross profit 
determines the margin of net profit. To secure an effective 
control of expenses and yet not to affect the volume of 
profitable operations is one of the most important and diffi- 
cult tasks of management. 

If the estimated expenses of each department are sub- 
mitted for the consideration of a central budget committee, 
composed of the principal executives of the company, and 
the departments are limited in their expenditures to the 
amount of the appropriations made by the budget commit- 



420 BUDGETARY CONTROL 

tee after consideration of the departmental estimates, an 
effective method of control is available. 

Formulation of a Financial Program 

The demand for capital is an imperative one. When 
funds are needed their procurement cannot be long delayed. 
To insure that it will be possible to secure them when needed, 
it is necessary to determine in advance the amount required 
and the time when required, so that plans may be made for 
their procurement. 

It is possible to do this in a systematic way only when 
comprehensive and accurate statements of the plans of all 
the departments are available, so that estimates of cash re- 
ceipts and disbursements which will result from these plans 
can be made and a program formulated for the procurement 
of any excess of disbursements over receipts. 

Coordination of All the Activities of the Business 

The previous discussion has emphasized the close rela- 
tionship between the activities of all the departments of a 
business. This relationship is so close that no one depart- 
ment can carry on its activities properly without a consid- 
eration of the activities of one or more of the other depart- 
ments. Neither can the executives of a business judge 
properly the past or contemplated activities of any one de- 
partment independently of the activities of the other depart- 
ments. 

To make possible the formulation of a well-balanced 
program for the business as a whole, it is essential that the 
plans of all the departments be presented for executive con- 
sideration and that the plans of the several departments be 
modified, if necessary, in order to bring about coordination. 
This can best be accomplished by the submission of formal 
estimates to a budget committee, and the formulation of 



ADVANTAGES AND LIMITATIONS 42 1 

these into a budgetary program, which will be enforced and 
controlled in some such manner as that discussed in the pre- 
ceding chapters. 

The Limitations of Budgetary Control 

Need for Consideration 

It is as essential that the limitations of budgetary con- 
trol be understood as that the benefits which may be derived 
from it be realized. Unless this be true the following re- 
sults are apt to happen: 

1. Too much will be expected from the budgetary program, and 

when it fails to fulfil expectations it may be thought useless 
and abandoned. 

2. Too much reliance may be placed on its operation which may 

result in too little emphasis on other methods of administrative 
control. 

3. It may be followed blindly which may bring results more detri- 

mental than those which arise from its absence. 

Important Limitations 

The most important and significant limitations of budg- 
etary control are the following: 

1. The budget program is based on estimates. Esti- 
mates cannot be made which are entirely accurate, and con- 
sequently they must be used with judgment and not fol- 
lowed arbitrarily. It is also necessary that provision be 
made for frequent revisions of these estimates as actual 
performance shows variations from the estimated perform- 
ance. 

2. Budgetary plans will not execute themselves. After 
budgets are prepared, every possible effort must be made to 
equal or exceed them. Detail plans must be made for their 
attainment and these plans must be enforced rigidly. 

3. Budgetary control cannot take the place of admin- 



422 BUDGETARY CONTROL 

istration. It is not its purpose to deprive executives of the 
necessary freedom of action which is essential to progressive 
management. Its purpose is to provide the information 
on which administrative decisions and administrative con- 
trol are based. 

4. Budgetary control cannot be perfected immediately. 
The procedure called for by the budgetary program is 
usually new to executives and it takes time to train them to 
make and use properly estimates of future operations. Too 
much should not be expected at the beginning of budgetary 
control. In many cases it is desirable to install budgetary 
control gradually so that the executives may be educated to 
its needs and purposes. 

Summary 

The advantages to be derived from budgetary control 
may be stated in outline form as follows : 

1. Coordination of Sales and Production: 

(a) By estimating sales possibilities and planning production 

to produce the goods necessary to meet these pos- 
sibilities. 

(b) By limiting the production to the amount necessary to 

meet probable sales demands as shown by the sales esti- 
mate, thus preventing an excess of inventory of finished 
product. 

2. Formulation of a Profitable Sales and Production Pro- 

gram: 

(a) By determining the lines of goods most desirable for a 

well-rounded sales program and adapting production, in 
so far as is consistent with the following paragraph, to 
produce the necessary quantity of these lines. 

(b) By determining the lines of goods most desirable for a 

well-rounded production program and planniug sales, in 
so far as is consistent with the preceding paragraph, to 
sell the amount of these lines necessary to secure eco- 
nomical production. 



ADVANTAGES AND LIMITATIONS 423 

3. Coordination of Sales and Production with Finances: 

(a) By considering the contemplated sales and production 

programs in terms of financial requirements and revising 
these programs, if necessary, to reduce the financial 
requirements to correspond to the financial program 
which is deemed possible and desirable. 

(b) By determining the financial requirements of the sales 

and production programs as revised in the manner pre- 
scribed in the preceding paragraph, and planning to se- 
cure funds to meet these requirements. 

4. Proper Control OF Expenditures: 

(a) By requiring the preparation by each department head of 

an estimate of the expenditures of his department during 
the budget period. 

(b) By requiring the submission of these estimates to the 

budget committee for consideration and approval. 

(c) By the prohibition of any expenditures in excess of the 

departmental estimates without the permission of the 
budget committee. 

(d) By requiring the submission of monthly reports showing a 

comparison between the actual expenditures for the 
month and the estimated. 

5. Formulation of a Financial Program: 

(a) By the estimating of cash receipts for each month 

based on the sales program and the estimate of col- 
lections. 

(b) By the estimating of cash disbursements for each 

month based on the production, purchasing, plant and 
equipment, and departmental expense budgets. 

(c) By determining the excess of disbursements over receipts 

and the preparation of a financial program which will 
secure funds to provide for this excess. 

6. Coordination of All the Activities of the Business : 

., (a) By the preparation by each department of an estimate of 
its activities during the budget period, 
(b) By the study of these departmental estimates by the 
departmental executives and the budget committee- 



424 BUDGETARY CONTROL 

(c) By the modification of the activities of each department 

to the end that they coordinate with the activities of 
each other department. 

(d) By the preparation of an estimated balance sheet and 

an estimated statement of profit and loss showing the 
anticipated results of the operations provided for by the 
budgetary program. 

(e) By the formulation of plans and policies which will make 

possible the attainment of the estimated results as 
shown by the estimated financial reports prepared as 
directed in the preceding paragraph. 

The limitations of budgetary control may be stated in 
outline form as follows: 

1 . The budgetary program is based on estimates. 

2. Budgetary plans will not execute themselves. 

3. Budgetary control cannot take the place of administration. 

4. Budgetary control cannot be perfected immediately. 



CHAPTER XXVI 

BUDGETARY CONTROL FOR NON-COMMERCIAL 

ENTERPRISES 

Scope of Previous Chapters 

The discussion in the preceding chapters has been con- 
fined to a consideration of the use of budgetary control in 
the administration of the commercial or profit-seeking enter- 
prise. This has been done for the following reasons : 

1. It is for such enterprises that budgetary control is most urgently 

needed at the present time. 

2. The development of budgetary control in connection with such 

enterprises has been very slow and standard methods have not 
been formulated. 

3. The literature dealing with the application of budgetary control 

of these enterprises is limited. There is considerable litera- 
ture dealing with the various parts of the budgetary procedure, 
but so far as the author is aware this text is the first attempt 
to discuss the budgetary process as a whole. On the other 
hand, there is a considerable body of literature dealing with 
budgetary control of non-commercial enterprises. 

For these reasons it is thought that this text will best 
serve its purpose by emphasizing the possible uses of budget- 
ary control by the commercial enterprise and the possible 
raethods by which its installation by such businesses may be 
effected. It is well to see, however, the other uses which 
may be made of it. 

Varied Uses of Budgetary Control 

Budgetary control has long been practiced by govern- 
mental units, educational institutions, and similar organiza- 
tions. Religious, social, and charitable institutions, such 

425 



426 BUDGETARY CONTROL 

as churches, Y. M. C. A.'s, and social service agencies, are 
accustomed to prepare budgets, although in some cases they 
are not carefully prepared nor rigidly enforced. There has 
been a considerable body of literature produced treating of 
its use for these purposes and this literature is readily avail- 
able to the reader. 

Although it is not thought worth while to enter into a 
detailed discussion of budgetary control for non-commer- 
cial enterprises, a brief description is given in this chap- 
ter of its use in connection with governmental units and 
educational institutions, with the hope that some benefit may 
be obtained by a comparison between the methods employed 
in these cases and those suggested for commercial enter- 
prises in the preceding chapters. 

Budgetary Control for Governmental Units 

A possible procedure to be followed in the formulation 
and execution of a budget for a city, state, or national gov- 
ernment, stated in outline form, is as follows : 

1 . Some time before the beginning of the fiscal year each 
department prepares an estimate of its expenditures for the 
year. For instance, in a state government, the State De- 
partment, the Treasury Department, the Department of 
Justice, etc., will prepare such an estimate. The depart- 
ment head will base his estimate on the estimates submitted 
by the bureau chiefs within his department. 

2. The head of the department will transmit this esti- 
mate with his approval to some official, usually the Treas- 
urer, Comptroller, Director of Finance, or Director of the 
Budget, who is designated by the law to receive the separate 
estimates and formulate them into a combined estimate for 
all departments. For brevity, we shall refer to this execu- 
tive as the Director of the Budget in the following discussion. 

3. The Director of the Budget, prepares an estimate of 



NON-COMMERCIAL ENTERPRISES 427 

the revenue for the fiscal year. He then submits a report 
to the chief executive (the Mayor, Governor, or President) 
showing a comparison of the estimated expenditures with 
the estimated revenues. 

4. The chief executive, and in many cases a Board of 
Review, Board of Estimate and Review, or Cabinet, con- 
sider the estimates received from the Director of the 
Budget. The departmental heads may be called into con- 
ference to give reasons for any increases requested by their 
departments. 

5. If the estimated expenditures exceed the estimated 
revenues, one of the following must be done: 

(a) Expenditures may be reduced. This involves a decrease in the 

estimates of one or more departments. The Chief Executive 
or his advisory board must decide which of the departmental 
estimates should be decreased. 

(b) Revenue may be increased. This necessitates the devising of 

new methods of taxation or the increasing of the present 
rates of taxation. 

(c) Additional funds may be secured from loans. This results in 

an increase of the indebtedness of the government. 

6. The chief executive transmits the budget as approved 
by him to the legislative body responsible for transforming 
it into law. He may accompany it with recommendations 
with reference to methods of raising new revenue if this is 
necessary, or with reference to the decrease of taxes if this 
is possible. 

7. The proposed budget is considered by the legislative 
body and such changes made as it deems fit. Usually the 
changes permitted are limited by law. In some cases the 
legislative body is given authority to decrease and strike 
out items, but cannot increase or add items. 

8. When the budget is approved by the legislative body, 
it becomes the working program for all the departments for 



428 BUDGETARY CONTROL 

the fiscal period. No department is permitted to exceed 
its budget allowance without a special dispensation of the 
legislative body. In some cases there is an ''emergency 
fund" included in the budget and put at the disposal of 
the chief executive. He may make allowances from this 
fund to departments which in his opinion are in need 
of additional funds. The amount of this fund is usually 
small. 

9. Proper records are kept that all expenditures of each 
department may be charged against its budget or ' ' appro- 
priation." Periodic reports are raade to a representative of 
the chief executive, showing a comparison between estimated 
expenditures and actual expenditures. 

It will be understood, of course, that the procedure 
stated in the foregoing outline is intended to be indicative 
only. The procedure varies somewhat in different govern- 
mental units. 

Budgetary Control of the National Government 

The ''Budget and Accounting Act," which establishes 
budgetary control for the federal government, was approved 
by the President on June 10, 1921. The complete act is 
given in Appendix A. The most important features of this 
act for our purposes are the following : 

1. It places the final authority and responsibility for the 
preparation and enforcement of the budget in the Presi- 
dent who is the chief executive of the administrative divi- 
sion of the government. 

2. It sets up a Budget Bureau which is responsible for 
the preparation and enforcement of the budgetary procedure. 
The executive head of this bureau is termed the Director of 
the Budget, and reports directly to the President. In this 
sense he may be termed a staff assistant to the President. 
In so far as the President delegates to him authority in the 



NON-COMMERCIAL ENTERPRISES 429 

enforcement of the budget, he acts as' an executive assistant 
instead of a staff assistant. 

3. It sets up a budget officer in each bureau who is re- 
sponsible for preparing the original estimate for his bureau. 
This results in placing the responsibility for initiating each 
budget on the unit which is responsible for its per- 
formance. 

4. It prescribes that each bureau chief will consider the 
budget as prepared by his budget officer and after he has 
approved it transmit it to the department chief. The de- 
partment head revises the estimates of the bureaus if he 
thinks this is necessary, and then combines these to make 
the estimate of his department. 

5. It prescribes that each department head will transmit 
the estimates of his department to the Director of the 
Budget. The latter will revise the departmental estimates 
if necessary, and will then combine these to make the com- 
plete estimate on expenditures. He will transmit this to- 
gether wath the estimate of revenues to the President, who 
will make any changes which he thinks necessary and sub- 
mit them with his approval to Congress. 

6. It creates a Comptroller General who is responsible 
for the form of the records and the procedures of the various 
departments, and for exercising control over the disburse- 
ments made under the appropriations which are made in 
response to the budget. 

It can be seen from the foregoing that the act sets up in 
general terms the procedure to be followed in the prepara- 
tion and enforcement of the national budget. 

Budgetary Control of State Governments 

The budgetary procedure of the several states varies to a 
considerable degree. The modem tendency is towards a 
more complete and comprehensive planning of financial 



430 BUDGETARY CONTROL 

Operations than that ^formerly employed. In recent years 
there has been some tendency towards a classification of the 
administrative activities of the state on a functional basis, 
and the creation of functional departments to carry on these 
activities. In those few states which have followed this 
plan there is usually created a department of finance in 
which is vested inter alia the responsibility for the prepara- 
tion and enforcement of the budget. 

Appendix B gives an extract from the ''Administrative 
Code " of the state of Ohio, which was approved by the Gov- 
ernor of the State on April 26, 1921. This extract shows 
the duties of the Department of Finance as defined in the 
law. This extract is interesting not only from the view- 
point of budgetary control, but also from the viewpoint of 
administrative control in general. 

Budgetary Control for Educational Institutions 

Budgetary procedure will vary somewhat as between 
the small college and the large university, and it will be 
slightly different in the endowed institution from that of the 
institution supported by public funds. 

To indicate briefly the principal considerations involved 
in the adoption of a procedure for an educational institution, 
a state university will serve our purpose. 

Budgetary Control for University 

The president of the university is responsible for the 
preparation of the annual budget and its submission to the 
board of trustees for approval. In its preparation he may 
employ various subordinates. The subordinates which 
may be employed and the procedure which they may fol- 
low in performing their tasks may be understood better by 
considering separately (a) the estimate of income, and (b) 
the estimate of expenditures. 



NON-COMMERCIAL ENTERPRISES 43 1 

The Estimate of Income 

The income of a state university may be derived from 
the following sources: 

1 . United States land grants 

2. Student fees 

3. Departmental sales 

4. Gifts 

5. Appropriations 

The income to be derived from United States land grants 
is not difficult to determine, for it is usually fairly uniform 
in amount. The income from student fees is dependent on 
the number of students enrolled. Since the attendance of 
a state university almost invariably increases each year, it 
is not difficult to determine the minimum amount of this 
item of income. It is, of course, impossible to determine 
the exact amount to be received from this source. 

Departmental sales arise chiefly from sales of the school 
of agriculture, and the income from this source must be 
based on an estimate of the quantity of product and services 
offered for sale and the probable price to be obtained for 
them. Possible sales of all departments and colleges must 
be considered. The income from gifts is ordinarily not 
large and is usually restricted in its uses; so it has little 
effect on the general budget. 

The income from appropriations cannot be determined 
until after the action of the legislature. The university 
ordinarily requests appropriations for sufficient amounts to 
meet the excess of disbursements over receipts as shown 
by its budget. In most cases more is requested than is 
obtained, and this necessitates a reduction in the original 
estimate of expenditures. 

The business manager or comptroller can best make the 
estimate of income. He may consult other executives in its 
preparation. After its completion he will transmit it to the 



432 BUDGETARY CONTROL 

president, who will combine it with the estimate of expend- 
itures to form the budget which he submits to the board of 
trustees. 

Estimate of Disbursements 

The expenditures of a university may be grouped broadly 
as follows: 

1. General Administration, including the salaries of "business" 

employees and clerical and stenographic assistants in all de- 
partments. 

2. Physical Plant Operation and Maintenance 

3. Capital Additions 

4. Teaching and Research 

(a) Library 

(b) Supplies 

(c) Instruction 

General Administrative Expenses 

The estimate of general administrative expense will 
be prepared by the controller. As a basis for this estimate 
he will receive an estimate from each department and ad- 
ministrative unit. The controller will indicate such revi- 
sions as he thinks are necessary and transmit the combined 
estimates to his superior officer, which may be the president 
or the business manager. In any case the president will 
make such revisions as he thinks are necessary and submit 
the estimate with his recommendations to the board of 
trustees. 

Physical Plant Operation and Maintenance 

The superintendent of buildings and grounds will pre- 
pare the original estimate for expenditures for physical' 
plant operation and maintenance. In its preparation he 
will be assisted by the purchasing agent, who will indicate 
the cost of materials and supplies needed by the program. 



NON-COMMERCIAL ENTERPRISES 433 

If the university has a plant engineer he may also assist in 
the preparation of the estimate. 

This estimate will be transmitted to the business man- 
ager who makes such revisions as he thinks necessary and 
transfers it to the president, who treats it likewise and sub- 
mits it to the b(?ard of trustees. 

Capital Additions 

The additions to property are usually made as the result 
of appropriations which are granted for the procurement or 
construction of specific property. Usually the president 
presents a building program to the board of trustees, and if 
it is adopted an attempt is made to secure appropriations 
for the construction of the buildings called for by the pro- 
gram. 

In many cases the program covers a period of several 
years but indicates the buildings which are most urgent. 
Appropriations may be requested in the order indicated by 
the program. In presenting the program to the board of 
trustees and later to the legislature, it is necessary to show 
estimates of cost. These estimates may be prepared by the 
university architect in cooperation with the university en- 
gineer and the purchasing agent. In some cases outside 
counsel may be employed to make these estimates. 

After appropriations are secured, contracts will be let for 
construction and the controller and business manager will 
supervise the expenditure of funds under the appropriation. 

Teaching and Research 

The expenditures under this heading may be subdivided 
to show separately the cost of the following : 

1. Maintenance of library 

2. Supplies and equipment 

3. Instruction 

28 



434 




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The director of the Hbraries will prepare an estimate of 
the cost of maintaining the library. He will also make an 
estimate of the cost of the necessary additions based on the 
requests of departments. In some cases there is a faculty 
committee which supervises such expenditures and passes 
on these requests. In some universities there are vari- 
ous other committees which pass on various kinds of 
expenditures. 

After the estimate is prepared it will be transmitted to 
the president, who will submit it to the board of trustees for 
approval. 

The estimate of supplies required by each department 
will be prepared by the head of each department and trans- 
mitted by him to the business manager, who will trans- 
mit it to the president, who will transmit it to the board of 
trustees. 

In the preparation of the estimate of instruction cost 
for a university, a procedure similar to the following may 
be used : 

1. An estimate will be prepared by each department showing the 

salaries recommended for each member thereof. A very- 
useful form for the preparation of this estimate is shown in 
Figure 52. 

2. The budget as prepared by the department will be forwarded by 

the head of the department to the dean of the college of which 
the department is a part. 

3. The budget as approved by the dean of the college will be trans- 

ferred to the budget committee. This committee may be com- 
posed of the deans of all the colleges. If the university has a 
functional organization, it will be composed of the staff officers 
in the office of the president. The president will be chairman 
of the committee. 

4. The budget committee will consider carefully the budget of each 

department and of each college. When necessary it may call 
into conference the heads of departments and deans of the 
colleges. In the consideration of the separate budgets it will 



NON-COMMERCIAL ENTERPRISES 437 

have in mind the budget of the university as a whole, which it 
will prepare from the separate budgets. 

5. After the budget has been approved by the budget committee, 

it will be transmitted to the president of the university. The 
president will submit the budget to the board of trustees with 
such recommendations as he may deem desirable. 

6. If it is desired to make any revisions in the original budget, the 

same procedure will be followed as in the making of the original 
budget. 

In the departmental salary budget (Figure 52a, b, c), 
Section I is useful in that it shows the ''class hours" re- 
quired to carry the desired program. It serves as a basis 
for estimating the required teaching staff. Column (5) 
of this section must be equal to column (2) of Section II, 
and column (2) of Section III. Section II is useful in 
showing the disposition of instructors' time. If the budget 
committee studies this section in connection with Section 
I, it can judge intelligently the claims of departments for 
additions to staff. Sections III and IV serve as a basis 
for the preparation of the financial budget. 

Budgetary Procedure 

A definite procedure should be established for the prepa- 
ration of all the foregoing budgets, so that they will all reach 
the president at the proper time and he can transmit them 
to the board of trustees at the same time. 

Summary 

No attempt has been made in this chapter to discuss a 
complete procedure for the preparation and execution of 
the budget of a non-coramercial organization. To do this 
would require a separate volume. Neither is it intended 
to offer the procedures briefly outlined in this chapter as 
those which can be adopted in toto by any particular or- 
ganization, although the procedures given are adapted 



438 BUDGETARY CONTROL 

from those with which the author is famiUar. It is in- 
tended that this chapter be only suggestive of methods 
employed by non-commercial enterprises in seeking ad- 
ministrative control through the operation of a budgetary 
system. 



APPENDIX A 

THE BUDGET AND ACCOUNTING ACT 

Following is the law, approved by the President June 
ID, 1 92 1, which establishes budgetary control for the fed- 
eral government. 

An Act to provide a national budget system and an independent audit 
of Government accounts, and for other purposes. 

Title I — Definitions 

Section i. This Act may be cited as the "Budget and Accounting 
Act, 192 1." 

Sec. 2. When used in this Act — 

The terms "department and estabUshment " and "department or estab- 
lishment" mean any executive department, independent commission, 
board, bureau, office, agency, or other establishment of the Government, 
including the municipal government of the District of Columbia, but do not 
include the Legislative Branch of the Government or the Supreme Court 
of the United States; 

The term "the Budget" means the Budget required by section 201 to 
be transmitted to Congress; 

The term "Bureau" means the Bureau of the Budget; 

The term "Director" means the Director of the Bureau of the Budget; 
and 

The term "Assistant Director" means the Assistant Director of the 
Bureau of the Budget. 

Title II — The Budget 

Sec. 201. The President shall transmit to Congress on the first day of 
each regular session, the Budget, which shall set forth in summary and in 
detail : 

(a) Estimates of the expenditures and appropriations necessary in his 
judgment for the support of the Government for the ensuing fiscal year; 
except that the estimates for such year for the Legislative Branch of the 
Government and the Supreme Court of the United States shall be trans- 

439 



440 APPENDIX 

mitted to the President on or before October 15th of each year, and shall 
be included by him in the Budget without revision; 

(b) His estimates of the receipts of the Government during the ensuing 
fiscal year, under (i) laws existing at the time the Budget is transmitted 
and also (2) under the revenue proposals, if any, contained in the Budget; 

(c) The expenditures and receipts of the Government during the last 
completed fiscal year; 

(d) Estimates of the expenditures and receipts of the Government dur- 
ing the fiscal year in progress; 

(e) The amount of annual, permanent, or other appropriations, includ- 
ing balances of appropriations for prior fiscal years, available for expendi- 
ture during the fiscal year in progress, as of November i of such year; 

(f) Balanced statements of (i) the condition of the Treasury at the end 
of the last completed fiscal year, (2) the estimated condition of the Treas- 
ury at the end of the fiscal year in progress, and (3) the estimated condi- 
tion of the Treasury at the end of the ensuing fiscal year if the financial 
proposals contained in the Budget are adopted; 

(g) All essential facts regarding the bonded and other indebtedness of 
the Government; and 

(h) Such other financial statements and data as in his opinion are 
necessary or desirable in order to make known in all practicable detail the 
financial condition of the Government. 

Sec. 202. (a) If the estimated receipts for the ensuing fiscal year con- 
tained in the Budget, on the basis of laws existing at the time the Budget 
is transmitted, plus the estimated amounts in the Treasury at the close of 
the fiscal year in progress, available for expenditure in the ensuing fiscal 
year, are less than the estimated expenditures for the ensuing fiscal year 
contained in the Budget, the President in the Budget shall make recom- 
mendations to Congress for new taxes, loans, or other appropriate action 
to meet the estimated deficiency. 

(b) If the aggregate of such estimated receipts and such estimated 
amounts in the Treasury is greater than such estimated expenditures for 
the ensuing fiscal year, he shall make such recommendations as in his opin- 
ion the public interests require. 

Sec. 203. (a) The President from time to time may transmit to Con- 
gress supplemental or deficiency estimates for such appropriations or ex- 
penditures as in his judgment (l) are necessary on account of laws enacted 
after the transmission of the Budget, or (2) are otherwise in the public 
interest. He shall accompany such estimates with a statement of the 
reasons therefor, including the reasons for their omission from the Budget. 



THE BUDGET AND ACCOUNTING ACT 441 

(b) Whenever such supplemental or deficiency estimates reach an 
aggregate which, if they had been contained in the Budget, would have 
required the President to make a recommendation under subdivision (a) of 
section 202, he shall thereupon make such recommendation. 

Sec. 204. (a) Except as otherwise provided in this Act, the contents, 
order, and arrangement of the estimates of appropriations and the state- 
ments of expenditures and estimated expenditures contained in the Budget 
or transmitted under section 203, and the notes and other data submitted 
therewith, shall conform to the requirements of existing law. 

(b) Estimates for lump-sum appropriations contained in the Budget 
or transmitted under section 203 shall be accompanied by statements show- 
ing, in such detail and form as may be necessary to inform Congress, the 
manner of expenditure of such appropriations and of the corresponding 
appropriations for the fiscal year in progress and the last completed fiscal 
year. Such statements shall be in lieu of statements of like character now 
required by law. 

Sec. 205. The President, in addition to the Budget, shall transmit to 
Congress on the first Monday in December, 1921, for the service of the 
fiscal year ending June 30, 1923, only, an alternative budget, which shall be 
prepared in such form and amounts and according to such system of classi- 
fication and itemization as is, in his opinion, most appropriate, with such 
explanatory notes and tables as may be necessary to show where the 
various items embraced in the Budget are contained in such alternative 
budget. 

Sec. 206. No estimate or request for an appropriation and no request 
for an increase in an item of any such estimate or request, and no recommen- 
dation as to how the revenue needs of the Government should be met, shall 
be submitted to Congress or any committee thereof by any ofificer or em- 
ployee of any department or establishment, unless at the request of either 
House of Congress. 

Sec. 207. There is hereby created in the Treasury Department a 
Bureau to be known as the Bureau of the Budget. There shall be in the 
Bureau a Director and an Assistant Director, who shall be appointed by the 
President and receive salaries of $10,000 and $7,500 a year, respectively. 
The Assistant Director shall perform such duties as the Director may desig- 
nate, and during the absence or incapacity of the Director or during a va- 
cancy in the office of Director he shall act as Director. The Bureau, under 
such rules and regulations as the President may prescribe, shall prepare for 
him the Budget, the alternative Budget, and any supplemental or deficiency 
estimates, and to this end shall have authority to assemble, correlate, re- 



442 APPENDIX 

vise, reduce, or increase the estimates of the several departments or estab- 
lishments. 

Sec. 208. (a) The Director, under such rules and regulations as the 
President may prescribe, shall appoint and fix the compensation of attor- 
neys and other employees and make expenditures for rent in the District 
of Columbia, printing, binding, telegrams, telephone service, law books, 
books of reference, periodicals, stationery, furniture, ofifice equipment, 
other supplies, and necessary expenses of the office, within the appropria- 
tions made therefor. 

(b) No person appointed by the Director shall be paid a salary at a 
rate in excess of $6, 000 a year, and not more than four persons so appointed 
shall be paid a salary at a rate in excess of $5,000 a year. 

(c) All employees in the Bureau whose compensation is at a rate of 
$5,000 a year or less shall be appointed in accordance with the civil-service 
laws and regulations. 

(d) The provisions of law prohibiting the transfer of employees of execu- 
tive departments and independent establishments until after service of 
three years shall not apply during the fiscal years ending June 30, 1921, and 
June 30, 1922, to the transfer of employees to the Bureau. 

(e) The Bureau shall not be construed to be a bureau or office created 
since January i, 1916, so as to deprive employees therein of the additional 
compensation allowed civilian employees under the provisions of section 6 
of the Legislative, Executive, and Judicial Appropriation Act for the 
fiscal years ending June 30, 1921, and June 30, 1922, if otherwise entitled 
thereto. 

Sec. 209. The Bureau, when directed by the President, shall make a 
detailed study of the departments and establishments for the purpose of 
enabling the President to determine what changes (with a view of securing 
greater economy and efficiency in the conduct of the public service) should 
be made in (i) the existmg organization, activities, and methods of busi- 
ness of such departments or establishments, (2) the appropriations there- 
for, (3) the assignment of particular activities to particular services, or 
(4) the regrouping of services. The results of such study shall be embodied 
in a report or reports to the President, who may transmit to Congress such 
report or reports or any part thereof with his recommendations on the mat- 
ters covered thereby. 

Sec. 210. The Bureau shall prepare for the President a codification of 
all laws or parts of laws relating to the preparation and transmission to 
Congress of statements of receipts and expenditures of the Government and 



THE BUDGET AND ACCOUNTING ACT 443 

of estimates of appropriations. The President shall transmit the same to 
Congress on or before the first Monday in December, 1921, with a recom- 
mendation as to the changes which, in his opinion, should be made in such 
laws or parts of laws. 

Sec. 211. The powers and duties relating to the compiling of esti- 
mates now conferred and imposed upon the Division of Bookkeeping and 
Warrants of the office of the Secretary of the Treasury are transferred 
to the Bureau. 

Sec. 212. The Bureau shall, at the request of any committee of either 
House of Congress having jurisdiction over revenue or appropriations, 
furnish the committee such aid and information as it may request. 

Sec. 213. Under such regulations as the President may prescribe, (i) 
every department and establishment shall furnish to the Bureau such in- 
formation as the Bureau may from time to time require, and (2) the Di- 
rector and the Assistant Director, or any employee of the Bureau when 
duly authorized, shall, for the purpose of securing such information, have 
access to, and the right to examine, any books, documents, papers, or rec- 
ords of any such department or establishment. 

Sec. 214. (a) The head of each department and establishment shall 
designate an official thereof as budget officer therefor, who, in each year 
under his direction and on or before a date fixed by him, shall prepare the 
departmental estimates, 

(b) Such budget officer shall also prepare, under the direction of the 
head of the department or establishment, such supplemental and deficiency 
estimates as may be required for its work. 

Sec. 215. The head of each department and establishment shall revise 
the departmental estimates and submit them to the Bureau on or before 
September 15 of each year. In case of his failure so to do, the President 
shall cause to be prepared such estimates and data as are necessary to 
enable him to include in the Budget estimates and statements in respect 
to the work of such department or establishment. 

Sec. 216. The departmental estimates and any supplemental or de- 
ficiency estimates submitted to the Bureau by the head of any department 
or establishment shall be prepared and submitted in such form, manner, 
and detail as the President may prescribe. 

Sec. 217. For expenses of the establishment and maintenance of the 
Bureau there is appropriated, out of any money in the Treasury not other- 
wise appropriated, the sum of $225,000, to continue available during the 
fiscal year ending June 30, 1922. 



444 APPENDIX 

Title III — General Accounting Office 

Sec. 301. There is created an establishment of the Government to be 
known as the General Accounting Office, which shall be independent of the 
executive departments and under the control and direction of the Comp- 
troller General of the United States. The offices of Comptroller of the 
Treasury and Assistant Comptroller of the Treasury are abolished, to take 
effect July i, 1921. All other officers and employees of the office of the 
Comptroller of the Treasury shall become officers and employees in the 
General Accounting Office at their grades and salaries on July i, 192 1, and 
all books, records, documents, papers, furniture, office equipment and other 
property of the office of the Comptroller of the Treasury shall become the 
property of the General Accounting Office. The Comptroller General is 
authorized to adopt a seal for the General Accounting Office. 

Sec. 302. There shall be in the General Accounting Office a Comp- 
troller General of the United States and an Assistant Comptroller General 
of the United States, who shall be appointed by the President with the 
advice and consent of the Senate, and shall receive salaries of $10,000 and 
$7,500 a year, respectively. The Assistant Comptroller General shall per- 
form such duties as may be assigned to him by the Comptroller General, 
and during the absence or incapacity of the Comptroller General, or during 
a vacancy in that office, shall act as Comptroller General. 

Sec. 303. Except as hereinafter provided in this section, the Comp- 
troller General and the Assistant Comptroller General shall hold office for 
fifteen years. The Comptroller General shall not be eligible for reappoint- 
ment. The Comptroller General or the Assistant Comptroller General 
may be removed at any time by joint resolution of Congress after notice 
and hearing, when, in the judgment of Congress, the Comptroller General 
or Assistant Comptroller General has become permanently incapacitated or 
has been inefficient, or guilty of neglect of duty, or of malfeasance in office, 
or of any felony or conduct involving moral turpitude, and for no other 
cause and in no other manner except by impeachment. Any Comptroller 
General or Assistant Comptroller General removed in the manner herein 
provided shall be ineligible for reappointment to that office. When a 
Comptroller General or Assistant Comptroller General attains the age of 
seventy years, he shall be retired from his office. 

Sec. 304. All powers and duties now conferred or imposed by law 
upon the Comptroller of the Treasury or the six auditors of the Treasury 
Department, and the duties of the Division of Bookkeeping and Warrants 
of the Office of the Secretary of the Treasury relating to keeping the per- 



THE BUDGET AND ACCOUNTING ACT 445 

sonal ledger accounts of disbursing and collecting officers, shall, so far as 
not inconsistent with this Act, be vested in and imposed upon the General 
Accounting Office and be exercised without direction from any other officer. 
The balances certified by the Comptroller General shall be final and con- 
clusive upon the executive branch of the Government. The revision by 
the Comptroller General of settlements made by the six auditors shall be 
discontinued, except as to settlements made before July i, 1921. 

The administrative examination of the accounts and vouchers of the 
Postal Service now imposed by law upon the Auditor for the Post Office 
Department shall be performed on and after July i, 1921, by a bureau in 
the Post Office Department to be known as the Bureau of Accounts, which 
is hereby established for that purpose. The Bureau of Accounts shall be 
under the direction of a Comptroller, who shall be appointed by the Presi- 
dent with the advice and consent of the Senate, and shall receive a salary of 
$5,000 a year. The Comptroller shall perform the administrative duties 
now performed by the Auditor for the Post Office Department and such 
other duties in relation thereto as the Postmaster General may direct. The 
appropriation of $5,000 for the salary of the Auditor for the Post Office 
Department for the fiscal year 1922 is transferred and made available for 
the salary of the Comptroller, Bureau of Accounts, Post Office Department. 
The officers and employees of the Office of the Auditor for the Post Office 
Department engaged in the administrative examination of accounts shall 
become officers and employees of the Bureau of Accounts at their grades and 
salaries on July i , 1921 . The appropriations for salaries and for contingent 
and miscellaneous expenses and tabulating equipment for such office for 
the fiscal year 1922, and all books, records, documents, papers, furniture, 
office equipment, and other property shall be apportioned between, trans- 
ferred to, and made available for the Bureau of Accounts and the General 
Accounting Office, respectively, on the basis of duties transferred. 

Sec. 305. Section 236 of the Revised Statutes is amended to read as 
follows: 

"Sec. 236. All claims and demands whatever by the Government of 
the United States or against it, and all accounts whatever in which the 
Government of the United States is concerned, either as debtor or creditor, 
shall be settled and adjusted in the General Accounting Office." 

Sec. 306. All laws relating generally to the administration of the de- 
partments and establishments shall, so far as applicable, govern the General 
Accounting Office. Copies of any books, records, papers, or documents, 
and transcripts from the books and proceedings of the General Accounting 
Office, when certified by the Comptroller General or the Assistant Comp- 



446 APPENDIX 

troller General under its seal, shall be admitted as evidence with the same 
effect as the copies and transcripts referred to in sections 882 and 886 of the 
Revised Statutes. 

Sec. 307. The Comptroller General may provide for the payment of 
accounts or claims adjusted and settled in the General Accounting Office, 
through disbursing officers of the several departments and establishments, 
instead of by warrant. 

Sec. 308. The duties now appertaining to the Division of Public 
Moneys of the Office of the Secretary of the Treasury, so far as they relate 
to the covering of revenues and repayments into the Treasury, the issue of 
duplicate checks and warrants, and the certification of outstanding lia- 
bilities for payment, shall be performed by the Division of Bookkeeping 
and Warrants of the Office of the Secretary of the Treasury. 

Sec. 309. The Comptroller General shall prescribe the forms, sys- 
tems, and procedure for administrative appropriation and fund accounting 
in the several departments and establishments, and for the administrative 
examination of fiscal officers' accounts and claims against the United States. 

Sec. 310. The offices of the six auditors shall be abolished, to take 
effect July i, 1921. All other officers and employees of these offices except 
as otherwise provided herein shall become officers and employees of the 
General Accounting Office at their grades and salaries on July i , 1921 . All 
books, records, documents, papers, furniture, office equipment, and other 
property of these offices, and of the Division of Bookkeeping and War- 
rants, so far as they relate to the work of such division transferred by sec- 
tion 304, shall become the property of the General Accounting Office. The 
General Accounting Office shall occupy temporarily the rooms now occu- 
pied by the office of the Comptroller of the Treasury and the six auditors. 

Sec. 311. (a) The Comptroller General shall appoint, remove, 
and fix the compensation of such attorneys and other employees in the 
General Accounting Office as may from time to time be provided for by 
law. 

(b) All such appointments, except to positions carrying a salary at a 
rate of more than $5,000 a year, shall be made in accordance with the civil- 
service laws and regulations. 

(c) No person appointed by the Comptroller General shall be paid a 
salary at a rate of more than $6,000 a year, and not more than four persons 
shall be paid a salary at a rate of more than $5,000 a year. 

(d) All officers and employees of the General Accounting Office, 
whether transferred thereto or appointed by the Comptroller General, 
shall perform such duties as may be assigned to them by him. 



THE BUDGET AND ACCOUNTING ACT 447 

(e) All official acts performed by such officers or employees specially 
designated therefor by the Comptroller General shall have the same force 
and effect as though performed by the Comptroller General in person. 

(f) The Comptroller General shall make such rules and regulations as 
may be necessary for carrying on the work of the General Accounting 
Office, including rules and regulations concerning the admission of 
attorneys to practice before such office. 

Sec. 312. (a) The Comptroller General shall investigate, at the seat 
of government or elsewhere, all matters relating to the receipt, disburse- 
ment, and application of public funds, and shall make to the President 
when requested by him, and to Congress at the beginning of each regular 
session, a report in writing of the work of the General Accounting Office, 
containing recommendations concerning the legislation he may deem neces- 
sary to facilitate the prompt and accurate rendition and settlement of ac- 
counts and concerning such other matters relating to the receipt, disburse- 
ment, and application of public funds as he may think advisable. In such 
regular report, or in special reports at any time when Congress is in session, 
he shall make recommendations looking to greater economy or efficiency in 
public expenditures. 

(b) He shall make such investigations and reports as shall be ordered 
by either House of Congress or by any committee of either House having 
jurisdiction over revenue, appropriations, or expenditures. The Comp- 
troller General shall also, at the request of any such committee, direct 
assistants from his office to furnish the committee such aid and informa- 
tion as it may request. 

(c) The Comptroller General shall specially report to Congress every 
expenditure or contract made by any department or establishment in any 
year in violation of law. 

(d) He shall submit to Congress reports upon the adequacy and effec- 
tiveness of the administrative examination of accounts and claims in the 
respective departments and establishments and upon the adequacy and 
effectiveness of departmental inspection of the offices and accounts of fiscal 
officers. 

(e) He shall furnish such information relating to expenditures and ac- 
counting to the Bureau of the Budget as it may request from time to 
time. 

Sec. 313. All departments and establishments shall furnish to the 
Comptroller General such information regarding the powers, duties, activi- 
ties, organization, financial transactions, and methods of business of their 
respective offices as he may from time to time require of them; and the 



448 APPENDIX 

Comptroller General, or any of his assistants or employees, when duly au- 
thorized by him, shall, for the purpose of securing such information, have 
access to and the right to examine any books, documents, papers, or records 
of any such department or establishment. The authority contained in this 
section shall not be applicable to expenditures made under the provisions 
of section 291 of the Revised Statutes. 

Sec. 314. The Civil Service Commission shall establish an eligible 
register for accountants for the General Accounting Ofhce, and the exami- 
nations of applicants for entrance upon such register shall be based upon 
questions approved by the Comptroller General. 

Sec. 315. (a) All appropriations for the fiscal year ending June 30, 
1922, for the offices of the Comptroller of the Treasury and the six auditors, 
are transferred to and made available for the General Accounting Office, 
except as otherwise provided herein. 

(b) During such fiscal year the Comptroller General, within the limit 
of the total appropriations available for the General Accounting Office, may 
make such changes in the number and compensation of officers and em- 
ployees appointed by him or transferred to the General Accounting Office 
under this Act as may be necessary. 

(c) There shall also be transferred to the General Accounting Office 
such portions of the appropriations for rent and contingent and miscella- 
neous expenses, including allotments for printing and binding, made for the 
Treasury Department for the fiscal year ending June 30, 1922, as are equal 
to the amounts expended from similar appropriations during the fiscal 
year ending June 30, 1921, by the Treasury Department for the offices of 
the Comptroller of the Treasury and the six auditors. 

(d) During the fiscal year ending June 30, 1922, the appropriations and 
portions of appropriations referred to in this section shall be available for 
salaries and expenses of the General Accounting Office, including payment 
for rent in the District of Columbia, traveling expenses, the purchase and 
exchange of law books, books of reference, and for all necessary miscella- 
neous and contingent expenses. 

Sec. 316. The General Accounting Office and the Bureau of Accounts 
shall not be construed to be a bureau or office created since January 1,1916, 
so as to deprive employees therein of the additional compensation allowed 
civilian employees under the provisions of section 6 of the Legislative, 
Executive, and Judicial Appropriation Act for the fiscal year ending June 
30, 1922, if otherwise entitled thereto. 

Sec. 317. The provisions of law prohibiting the transfer of employees 
of executive departments and independent establishments until after serv- 



THE BUDGET AND ACCOUNTING ACT 449 

ice of three years shall not apply during the fiscal year ending June 30, 
1922, to the transfer of employees to the General Accounting Office. 

Sec. 318. This Act shall take effect upon its approval by the Presi- 
dent: Provided, That sections 301 to 317, inclusive, relating to the General 
Accounting Office and the Bureau of Accounts, shall take effect July i, 
192 1. 

Approved, June 10, 1921. 



29 



APPENDIX B 

ADMINISTRATIVE CODE FOR THE STATE 

OF OHIO 

Department of Finance 

Sec. 154-28. The department of finance shall have power to exercise 
control over the financial transactions of all departments, offices and insti- 
tutions, except the judicial and legislative departments, as follows: 

(i) By prescribing and requiring the installation of a uniform system of 
accounting and reporting, as to accruals of revenue and expenditures neces- 
sary in certifying that funds are available and adequate to meet contracts 
and obligations. 

(2) By prescribing and requiring uniform order and invoice forms and 
forms for financial reports and statements, and by requiring financial re- 
ports and statements. 

(3) By requiring itemized statements of expenditures proposed for any 
specified future period to be submitted to the department, and by approv- 
ing or disapproving all or any part of such proposed expenditures. 

(4) By requiring orders, invoices, claims, vouchers or payrolls to be 
submitted to the department, where such submission is prescribed by law 
or where the governor shall deem such submission necessary, and by ap- 
proving or disapproving such orders, invoices, claims, vouchers or payrolls. 

(5) By supervising and examining accounts, the expenditures and re- 
ceipts of public money and the disposition and use of public property, in 
connection with the administration of the state budget. 

(6) By prescribing the manner of certifying that funds are available 
and adequate to meet contracts and obligations. 

(7) By prescribing uniform rules governing forms of specifications, 
advertisements for proposals, opening of bids, making of awards and con- 
tracts, governing purchases of supplies and performance of work. 

(8) By reporting to the attorney general for such action, civil or crimi- 
nal, as the attorney general may deem necessary all facts showing illegal 
expenditures of the public money or misappropriation of public property. 

(9) By prescribing rules and regulations for carrying into effect any or 
all of the other powers herein granted. 

450 



Administrative code for ohio 451 

No provision of law authorizing or requiring any department, office, or 
institution to keep accrual, encumbrance or cost accounts or to exercise fiscal 
management and control over or with respect to any institution, activity 
or function of the state shall be so construed as to exclude such department, 
office or institution from the control of the department of finance herein 
specified, but the power of the department of finance herein provided for 
shall apply and relate to such accounts and reports of all such departments, 
offices and institutions. 

Sec. 154-29. As used in section 154-28 of the General Code: 

"Order" means a copy of a contract or a statement of the nature of a 
contemplated expenditure, a description of the property or commodity to 
be purchased or service to be performed, other than services of officers 
and regular employes of the state, and per diem of the national guard, and 
the total sum of the expenditures to be made therefor if the same is fixed 
and ascertained, otherwise the estimated sum thereof. 

"Invoice" means and includes estimates or contracts, or a statement 
showing delivery of the commodity or performance of the service described 
in the order, and the date of the purchase or rendering of the service, or a 
detailed statement of the things done, material supplied or labor furnished, 
and the sum due pursuant to the contract or obligation. 

"Voucher" means the order and invoice as herein defined ; and where- 
ever in the General Code the word "voucher" is used it shall be held to 
have the meaning herein defined. 

" Public money " shall have the meaning defined in section two hundred 
and eighty-six of the General Code. 

All orders and invoices shall specify the appropriation account from 
which they are payable. 

Sec. 154-30. If any requirement of the department of finance re- 
specting the submission of statements of proposed expenditures, or orders, 
invoices, claims, vouchers or payrolls is not complied with, or if any state- 
ment of proposed expenditures, or any order, invoice, claim, voucher or 
payroll is submitted to and disapproved in whole or in part by the depart- 
ment of finance, the department shall have authority to notify the auditor 
of state thereof, and such auditor shall not issue any warrants on the 
treasury in payment of such expenditure, claim or voucher. 

The department of finance may certify to the auditor of state any order 
or statement of proposed expenditures approved by it, and direct the proper 
appropriation account or accounts to be charged therewith, or with the 
estimated amount thereof, in which event the sum so certified shall be a 
prior charge on such appropriation account or accounts, available only for 



452 APPENDIX 

the payment of invoices issued against such order, or expenditures within 
such statement, until the final invoice therefor is filed with the auditor of 
state, or until the department of finance shall certify that such order and 
the obligation recited therein have ceased to be an obligation against the 
state, or such proposed expenditures have been made or abandoned in whole 
or in part. 

Whenever any commodity or service included in such order or statement 
so certified is delivered or performed, or whenever any payment is due upon 
any contract or obligation covered thereby, an invoice shall be filed with 
the auditor of state therefor. The total of all invoices issued against any 
such order shall not exceed the sum of such order or the estimated sum 
appearing on such order. 

Sec. 154-31. The department of finance shall : 

(i) Prepare and report to the governor, when requested, estimates of 
the income and revenues of the state, and devise new forms of revenue for 
the state; 

(2) Prepare and submit to the governor biennially, not later than the 
first day of January preceding the convening of the general assembly, state 
budget estimates; 

(3) Publish, from time to time, for the information of the several de- 
partments and of the general public, bulletins of the work of the depart- 
ment; 

(4) Investigate duplication of work of the departments and the effi- 
ciency of the organization and administration of departments, and formu- 
late plans for the further coordination of departments. 

Sec. 1 54-32. In the exercise of any of the powers mentioned in section 
154-28 of the General Code, the department of finance shall have the power 
to compel the attendance and testimony of witnesses, to administer oaths 
and to examine such persons as it may deem necessary, and compel the 
production of books and papers. The orders and subpoenas issued by the 
department in pursuance of the authority in it vested by this section may 
be enforced, on the application of the director of finance, by any court of 
common pleas by proceedings in contempt therein as provided by law. 

Sec. 154-33. Ill the preparation of state budget estimates the direc- 
tor of finance shall, not later than the fifteenth day of September in the 
year preceding the regular session of the general assembly, distribute to all 
departments, offices and institutions of the state government, the blanks 
necessary for the preparation of budget estimates, which shall be in such 
form as shall be prescribed by the director of finance, to procure, among 
other things, information as to the revenues and expenditures for the two 



ADMINISTRATIVE CODE FOR OHIO 453 

preceding fiscal years, and appropriations made by the previous general 
assembly, the expenditures therefrom, encumbrances thereon, and the 
amounts unencumbered and unexpended ; an estimate of the revenues and 
expenditures of the current fiscal year, and an estimate of the revenues and 
amounts needed for the respective departments, offices, and institutions 
for the two succeeding fiscal years for which appropriations have to be 
made. Each department, office and institution shall, not later than the 
first day of November, file in the office of the director of finance its esti- 
mate of receipts and expenditures for the succeeding biennium. Such 
estimate shall be accompanied by a statement in writing giving facts and 
explanations of reasons for each item of expenditure requested. The 
director of finance may in his discretion make further inquiry and in- 
vestigation as to any item desired. He may approve, disapprove or alter 
the estimates, excepting those for the legislative and judicial departments 
of the state government. Such estimates as revised by him shall con- 
stitute the state budget estimates which the department of finance is 
required by this chapter to submit to the governor. 

Sec. 1 54-34. The governor shall, as soon as possible and not later than 
four weeks after the organization of the general assembly, submit a pro- 
posed state budget in the form of an appropriation bill or bills and a state- 
ment showing the amounts recommended by him to be appropriated to the 
respective departments, offices and institutions and for all other public pur- 
poses, the estimated revenues from taxation, the estimated revenues from 
sources other than taxation, and an estimate of the amount required to be 
raised by taxation. 

Sec. 154-35. Each department, office and institution of the state 
government, other than the legislative and judicial departments thereof, 
shall, before any appropriation to such department becomes available for 
expenditure, prepare and submit to the department of finance an estimate 
of the amount required for each specific purpose within the appropriation, 
or items of appropriation, as made by the general assembly, and accounts 
shall be kept and reports rendered to the department of finance showing 
the expenditure for each such purpose. The department of finance shall 
exercise such control over items of appropriation accounts created by the 
general assembly, with respect to changes and adjustments therein within 
the general scope of a specific appropriation, as may be committed to it by 
any act making appropriations, and shall in general exercise such control 
over the expenditure of appropriations, in addition to that specifically pro- 
vided for in this chapter, as may be so committed to it. 

Sec. 154-36. The papers, statements and copies thereof required by 



454 APPENDIX 

section 270-6 of the General Code to be filed in the office of the president of 
the "Sundry Claims Board" therein provided for shall be hereafter de- 
livered to and filed in the office of the department of finance, and such de- 
partment shall discharge all the duties provided for in said section of the 
General Code with respect to the filing, delivery and preservation of such 
papers, statements and copies thereof. The director of finance shall in- 
clude all claims allowed by the " Sundry Claims Board " in the state budget 
estimates. 

Sec. 154-37. The department of finance shall succeed to and exercise 
all powers and perform all duties vested by sections one thousand eight 
hundred and forty-six and one thousand eight hundred and forty-seven of 
the General Code jointly in the secretary of state and the auditor of state, 
which said powers are hereby transferred to and vested in said department. 

The department of finance shall succeed to and exercise all powers of the 
state purchasing agent in the office of the secretary of state, and the secre- 
tary of state and auditor of state with respect to the purchase of supplies 
and equipment required for the use and maintenance of state officers, 
boards and commissions, the commissioners of public printing and the 
supervisor of public printing, and shall exercise all powers and perform all 
duties as to purchases heretofore vested in the Ohio board of administra- 
tion under the provisions of section one thousand eight hundred and forty- 
nine of the General Code. Wherever powers are conferred or duties im- 
posed upon any such departments, offices or officers with respect to the 
matters and things herein mentioned, such powers and duties shall be con- 
strued as vested in the department of finance. In addition to the powers so 
transferred to it, the department of finance shall have power to purchase 
all other supplies, material and equipment for the use of the state depart- 
ments, offices and institutions, excepting the military department and in- 
stitutions, administered by boards of trustees, and, excepting as to such 
department and institutions, to make contracts for and superintend the 
telephone and telegraph service for the state departments, offices and in- 
stitutions. So far as practicable, the department of finance shall make all 
purchases under authority of this chapter from the department of public 
welfare in the exercise of the functions of said department in the manage- 
ment of state institutions. 

Sec. 1 54-38. The tax commission of Ohio shall be a part of the depart- 
ment of finance for administrative purposes, in the following respects: The 
director of finance shall be ex officio the secretary of said commission, shall 
succeed to and perform all of the duties of the secretary of said commission, 
and shall exercise all powers of said secretary as provided by law; but such 



ADMINISTRATIVE CODE FOR OHIO 455 

director may designate any employe of the department as acting secretary 
to perform the duties and exercise the powers of secretary of the commis- 
sion. All clerical and other agencies for the execution of the powers and 
duties vested in said tax commission of Ohio shall be deemed to be in the 
department of finance, and the employes thereof shall be deemed to be 
employes in said department and shall have and exercise all authority 
vested by law in the employes of such commission. But the tax com- 
mission of Ohio shall have direct supervision and control over, and power of 
appointment and removal of, such employes whose positions shall be desig- 
nated by the governor as fully subject to the authority of such commission. 



APPENDIX C 
A TRUST COMPANY BUDGET SYSTEM 

By Stuart H. Patterson, Comptroller of the 
Guaranty Trust Company of New York 

The Guaranty Trust Company has received a number of requests for an 
explanation of its budget system for expenses. Thinking that possibly 
other of its correspondents might desire to utilize this method, the following 
brief description of the system has been prepared. 

The first step in this matter is to make a careful classification of the va- 
rious expenses, so that it will be possible to locate readily any differences 
between the budget allowance and the actual expenditures. The second 
step is to estimate carefully the probable expenditure under each classifi- 
cation, by months, for the coming year; and after the estimates have been 
duly approved by the Executive Officers, to distribute them by months on 
an Appropriation Sheet, the notations being made thereon in pencil. 

The purpose of preparing the Appropriation Sheet in pencil is to permit 
changes to be made from time to time during the year, either because of 
additional appropriations, or because some appropriation, say, for adver- 
tising, may not be expended until a later month than was anticipated, and 
consequently the appropriation should be carried along until such time as 
the expenditure actually takes place. The amounts should be distributed 
as well as possible over the probable months the expenditures will take 
place, with a notation on the budget to "carry along" such item, that is, 
to carry it along as an appropriation until required. As soon as a month 
is closed, the appropriations applicable to that month are inserted in ink. 

Each month the appropriations are carried from the Appropriation 
Sheet to the Expense Statements, and entered opposite the actual 
expenditures under each classification. 

The Expense Statements are divided into a Monthly Statement and a 
Cumulative Statement from January i to the end of the month just closed. 
The Cumulative Statement carries a memorandum column of the budget 
for the entire year for each classification. With this arrangement the state- 
ment shows at all times the amount each department or classification may 
spend, and, should the budget exceed its limit during one month, the lee- 
way that exists for making up the deficiency in some other month. 

456 



A TRUST COMPANY BUDGET SYSTEM 457 

The budget system is really very simple, but it is effective in indicating 
the probable expenses for a year before the expenditures are incurred, in- 
stead of giving an unsatisfactory review of them after the year is closed. 
This system also promotes economies which might otherwise be overlooked. 

A copy of the instructions regarding the 1919 Budget, which were sent 
to Department Heads, follows: 

1919 Budget 
It is desired that the budget for conducting the business for the year 191 9 
shall be in the hands of the Managing Committee by December i , 191 8, and 
the Officers in charge of all departments are requested to have the figures 
carefully prepared by that date and delivered to Mr. 

In preparing the budget each department shall show separately by 
months the amounts of salaries, suppers, postage and stationery, and other 
items. They shall also show the details which go to make up the "other 
items. " 

An illustration of the budget form is as follows: 

Budget Statement of Department 



FOR Year i 


919 














Other 


Salaries 


Suppers 


Postage 


Stationery 


Items 


$ 1,950 


$ 5 00 


1 40.00 


$ 80.00 


$ 35 00 


1,950 


5.00 


40.00 


80.00 


35 00 


1,950 


10.00 


40.00 


80.00 


35 00 


1,950 


5.00 


50.00 


80.00 


35 00 


1,950 


5.00 


40.00 


80.00 


35 00 


1,950 


10.00 


50.00 


80.00 


35 00 


1,950 


5.00 


40.00 


80.00 


35 00 


1,950 


5.00 


40.00 


80.00 


35 00 


1,950 


10.00 


50.00 


80.00 


35 00 


1,950 


5.00 


40.00 


80.00 


35 00 


1,950 


5.00 


40.00 


80.00 


35 00 


1,950 


10.00 


50.00 


80.00 


35 00 



January 

February 

March 

April 

May 

June 

July 

August 

September 

October 

November 

December 

$23,400 $ 8c. 00 $520.00 $960.00 $420.00 

Detail of Other Items 

Repairs to coin wrapping machine $ 60 . 00 

Rental of Telautograph machines 210 .00 

Inspection of adding machines 12 .00 

Photostatic expenses 120 .00 

Repairs to money truck 12 . 00 

$414.00 



458 APPENDIX 

Each department should keep a copy of its budget, and if during the 
year it becomes necessary to expend money for some item not included in 
the budget, it should be the duty of the Officer in charge of such department 
to see that an additional appropriation be granted before the expenditure is 
incurred. 

Requests for additional appropriations should be made to the Comp- 
troller in writing on the form prepared for that purpose, together with a 
memorandum showing why the additional expense is necessary. The 
Comptroller has authority to grant such additional appropriations but 
should he decline to approve any appropriation either because he believes 
it to be unnecessary, or because he thinks the matter should have the atten- 
tion of the Officers Meeting, it may be presented to the Officers Meeting 
through the Vice-President responsible for the operation of the department 
making the request. 



A TRUST COMPANY BUDGET SYSTEM 



459 



Guaranty Trust Company of New York shbettno.! 

Summary of Expenses for Month of 192 




ayiiABOS 


BtmPXBS 


POSTAOB AND 
8TATI0NEBT 


OTHXR 

rrsuB 


TOTAL 
BXPENSM 


APPRO- 
PBIATIONS 


PREVIOUS 
UONTH 


BAIOCIIONTB 
LABTTSAB 


EXPENSE OF SECURING 
BUSINESS 

New Business Department 

See Sheet 2 
Publicity Department 

See Sheet 2 
Bond Department 

See Sheet 2 
5th Ave. Office 

See Sheet 5 
Madison Ave. Office 

See Sheet 6 

1. Officers' StJaries 

2. " Lunches 

3. Foreign Representatives 

4. Genenil Traveling after 

Business 

6. Library 

7. Income Tax Dept. 
8. 

9. 

EXPENSE OF TRANS. 

ACTING BUSINESS 

CcBRmrr Opebatinq 

Main Office See Sheet 3 

etb Ave. Office See Sheet 6 

Madison Ave. Office 

See Sheet 6 

Fdcw bi Pouct 
Main Office See Sheet 3 
6tb Ave. Office See Sheet 6 
Madison Ave. Office 

See Sheet 6 

Main Office * See Sheet 4 
fith Ave. Office See Sheet 6 
Madison Ave. Office 

SeeShvete 

310. Officers' Salariea 

311. " Lunches 

Main Office See Sheet 4 
6th Ave. Office See Sheet 5 
Madison Ave. Office 

See Sheet 6 

TOTAL EXPENSES 




























































































































































































































! 
] 












































1 ; 
1 .1 




















1 






















1 


_ 






















REMARKS 



46o 



APPENDIX 



Expenses of Securing Business Month of 



SHEET No. 2 
192 



NEW BUSINESS 

30. Salaries 

31. Additional War Com- 

pensation * 

32. Suppers 

83. Stationery & Supplies 

34. Postage 

35. Traveling Expenses N.Y. 

Men 

36. Telegrams & Telephone 

Tolls 

37. Entertainment 

38. Other Expenses 
Out of Town Men 

Salaries 
Rent 
Expenses 
Traveling 



Total 



PUBLICITY 

60. Salaries 

61. Additional War Com- 

pensation 

62. Suppers 

63. Stationery & Supplies 

64. Postage 

65. Traveling Expenses 

66. Printing & Circulars 

67. Telegrams & Telephone 

Tolls 

68. Entertainment 

69. Other Expenses 

70. Advertising in Publica- 

tions 

71. Oeoeral Advertising & 

Publicity 
72. 
73. 
74. 

Tots) 

BOND DEPARTMENT 

100. Trading Div. 

101. Distributing Div. 

102. City Salesmen 

103. Outside Dealers 

104. Municipal Div. 

105. Special Sales Div. 

106. Correspondence Div. 

107. Executive Secretaries 

108. Corporation & New Busi- 
ness Div. 

109. Administration 
Accounting, &e. 

110. Undistributed Salarim 
111. 

112. 

113. Statistical 

114. Investigation Div. 

116. Outside Investigations 

t Examinations 

115. Out of Town Offices- 
Rent 

117. Salaries 

118. Private Wir« 
IIV, Traveling 

131. ^^ 

132. 

133. 

134. Bajma* 

135. AoditioDal War Com- 
pensa,tion 

US. Tdepbone Tolls— Tele- 
grams & Cables 

127. Stationery A Supplies 

128. Circulars & Printed 
Matter 

129. Postage 

130. Traveling Expenses 

131. Entertainment 

132. Advertising 

133. Stock Ticker 
134. 

as. 

IM. 

m. 
us. 

Totd 



A TRUST COMPANY BUDGET SYSTEM 



461 



Expenses of Transacting Business — ^Main 0£Bce Month of 



SHEET No. 3 
192 



CURRENT OPERATING 

DlPABTMINT 

[60. Accounting 

161. Analysis 

[62. Auditing 

163. Archivee 

164. Bookkeeping 

165. Collection 
186. TeUera 

167. Coupon 

168. Credit 

169. Chief Clerk's 
70. Emergency 
.71. General Pages 

172. FUing 

173. Loan 

174. Mailing 
:75. Messengers 

176. Reorganisation 

177. Registration 

178. Securities 

79. Stenographers — General 
.80. Secretaries— Executive 

181. Supply Dept. Operating 

182. Special Officere and 

Watchmen 

183. Stock Bookkeeping 

184. Transfer 
Teleplone, Tetegrapb & 

Cable 
85. Salaries Operators 

Service 
87. Undistributed Tolls 
188. Trust 
.89. Vault 

190. Expressage i Mail In- 
surance 
Foreign Department 
;9t. Salaries 
Suppers 
Travel 
Telegrams, Cables & 

Tel. Calls 
Postage i Express 
Stationery & Supplies 
Sundries 



200. 

201. , 

202. 

203. 

204. 

205. 

206. 

207. 

208. 

209. 

21c. 

211. 

212. 

213. 

214. 

215. 

Total 

FvasD BI POUCT 

230. Resident Attorney 

231. Legal & Professional Fees 

232. Directors & Committee 

Fees . 

233. Examinations & Elec- 

tions, 

234. Insurance Liability & 

Fire 

235. Fidelity Bonds 

236. Dining Room 

237. Customers' Check Books 

Free 
238. 
239. 
240. 
241. 
242. 
243. 
244. 
245. 

Total 



462 



APPENDIX 



Expenses of Transacting Business — Main OflSce (Continued) Month of 



SHEET No. 4 
192 



OviBHEAO 

Rent — 140 Broadway 
Salaries 
Elec. Current 
Steam 

Materials & Repairs 
Taxes, Real Estate 
Water 

Burglar Alarm 
Other Items 
Postage & Stationery 



Rents Received 

271. Other N. Y. Rentals 

272. Stock & News Tickers 

273. Drinking Water & Ice 

274. Laundry & Towels 
273. Clearing House & Fed. 

Reserve Charges 

276. N. Y. & Other Banking 

Dept. Fees 

277. Furniture and Fixtures 

Repairs 
Undistributed Items; 

278. SUtionery & Books 

279. Supplies Other Than 

Stationery 

280. Postage 

281. Suppers 

282. Traveling Incident to 

Current Business 

283. Loss on Obsolete SU- 

tionery 

284. General 

285. New Furniture, Fixtures 

& Equipment 

286. Alterations 
287. 
288. 
289. 
390. 
201. 
292. 
293. 
294. 
295. 
296. 
297. 
298. 
29». 
300. 
301. 
302. 
303. 
304. 



TOTAL TRANSACTING 
BUSINESS 

NON PRODUCTIVE 
EXPENSES 

320. OfSoersi Clerks on War 

Duty 

321. Pensions A Donations to 

Employees 

322. Educational 

323. Guaranty Club 

324. Subscriptions, Dues, eto. 
326. Welfare Dept. 

326. Medical Supplies i Ex- 

aminations 

327. Liberty Loan Expenses 

328. Additional Compensa- 

tion a/o War 
329. 
330. 
331. 
332. 
333. 
334. 
338. 
336. 
337. 
338. 
339. 
340. 

Total 



A TRUST COMPANY BUDGET SYSTEM 



463 



Guaranty Trust Company of New York ™^ ^'' ' 

Summary of Expenses for January Ist to 192 




BiXMSOB 


fltTPPKBfl 


POSTAQI AND 
8TATI0NBET 


OTHBI 

rmu 


TOTAL 
■XFIMSia 


APPEO- 
I«IATIONS 


TOTAL AjniO- 
PBUTIOHS 
rOBTBAB 


■XPnoM 
tuarmaoo 

LASTTBAB 


EXPENSE OF SECX7RINQ 

BUSINESS 
N«w BosnegB Department 

See Sheet 8 
Publieity Department 

See Sheet 8 
Bond Dq>sttmant 

See Sheet 8 
Sth Ave. Offise 

See Sheet 11 
Madison Ave. Office 

See Sheet 12 

1. Officen' Salaries 

2. " Lunches 

3. Foreign Representatives 

4. General Traveling after 

Bueioeas 

6. General Entertaining 
0. Library 

7. Income Tax Dept. 
8. 

9. 

EXPENSE OF TRANS 

ACTING BUSINESS 

Cdbrent OplBATntQ 

Main Office See Sheet 9 

Sth Ave. Office See Sheet U 

Madison Ave. Office 

See Sheet 12 

Fdcio bt Polict 
Main Office See Sheet 9 
Sth Ave. Office See Sheet 11 
Madison Ave. Office 

See Sheet 12 

OvBBaiAD 

Main Office See Sheet 10 
5tb Ave. Office See Sheet 11 
Madison Ave. Office 

See Sheet 12 

310. Offieets' Salaries 

311. " Lunches 

NoN PBOoucnra Expenses 
Main Office See Sheet 10 
6tb Ave. Office See Sheet 11 
Madison Ave. Office 

See Sheet 12 

TOTAL EXPENSES 











































































































































































































































































































































■ !■ 




































REMARKS: 
Notb: Sheets 9, 10, 11 and 12 are the aame as aheeta 2 to 6, except that the oolumns are headed the aamc M 
sheet?. 



464 



APPENDIX 



Request for Appropriation 

Authority is hereby requested for an increase of 

in the budget for the 

beginning 



$ 

Department, Classification No.. 



.192 , for the following reasons: 



Date- 



Request granted for $. 



192 Signed by. 



Comptroller. 



A TRUST COMPANY BUDGET SYSTEM 



465 



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1 II 1 11 1 1 1 


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January 

February 

March 

April 

May 

June 

July 

August 

September 
1 October 
1 November 

December 


e2 




January 

February 

March 

April 

May 

June 

July 

August 

September 

October 

November 

December 


3 
e2 




January 

February 

March 

April 

May 

June 

July 

August 

September 

October 

Noveniber 

December 


1 



30 



INDEX 



Accounting, 

data and statistics, 252-253, 272 
department, 40, 66, 262, 293, 389 
methods, 189, 194, 249 
period, length of, 34, 310 
Advertising, 

appropriation, 107, 112 

report, 117-121 
budget, 106-123 

control of, 1 19-123 

form of, 1 1 8- 1 20 

preparation of , 116-118 
cost, calculating, 108-111, 364 
expenditures report, 122 
purpose, 1 1 2- 1 14 
purpose vs. method of, 115 
vs. selling expense, 106, 283-284 

B 

Balance sheet, 

accounts payable, 347, 355 
assets, fixed, 344-345» 348, 354, 356 
based on estimates, 7, 50, 203, 329 
bonds payable, 348, 356 
capital stock, 348, 356-357 
cash estimate, 340-341, 350 
comparative, 351 
deferred charges, 345, 355 
estimated, 333-358, 360 
estimated and actual compared, 

369 
forms, 339, 351, 369 
good- will, 346 
income, accrued, 344 
inventories, 343-344, 353-354 
liabilities, accrued, 347 
liabilities, fixed, 356 
mortgages payable, 348, 356, 365 



Balance sheet — Continued, 

notes payable, 346-347, 350, 355, 
357 

notes receivable, 341-342, 352 

preparation of, 332, 340 

ratio of current assets to current 
liabilities, 357-358 

reports, use of financial, 335-337 

standard forms, 335-372 

surplus, 348, 357, 366 
Bank loans, 

financial program for, 318 
Board of directors, 

authority of, 21-24 

budgetary control by, 7, 48, 52-53, 
63, 287, 370 

budgets submitted to, 23, 53 

periodic reports to, 8, 24, 50, 290 
Budget act, 

federal, 439-449 

state (Ohio), 450-455 
Budgetary control, 

advantages of, 416-424 

as coordinating several depart- 
ments, 3, 12, 299, 416-423 

chart of procedure, 394 (insert) 

defined, 3-1 1 

educational institutions, 430 

essential features, 8 

federal law, defined, 439 

governmental units, 426-427 

installed, 28-53, 4^2 

limitations of, 421-424 

manual on, 42, 374-395 

modern tendency toward, lo-ii 

need for, 12-27, 54 

non-commercial enterprises, 425- 
438 

organization for, 43-53, 375 



467 



468 



INDEX 



Budgetary control — Continued , 
period, length of, 29, 34-36, 85, 308, 

310, 314, 338, 375 
popular conception of, 4 
program for, 35, 41, 419, 421 
purposes, 12, 27, 35 
state governments, 429-430 
state university, 430-437 
trust company, 456-465 
Budgets, (See also "Estimates"; also 

various classes of budgets under 

their own headings) 
committee, 

duties of, 7, 47-49, 204, 266, 378, 
380, 394, 419-423 

members, 7, 47, 376 

periodic reports to, 8, 51, 187, 
204, 224, 264, 268, 290, 293, 
320, 368, 393 
controlling sales, 80-81 
departmental, contents of, 7-8, 298, 

300 
governmental, direct control of, 

45-47, 444-449 
governmental, types of, 439-443, 

450-455 
priority list used in, 83 
revised, 81, 206, 208-209, 224, 294, 

319, 332, 338, 348, 366-367 
state university, 430-437 
system of, 11, 46, 299 
trust company, 456-465 
types of, 9-10, 70, 140, 202, 207-208 
Business activities, 
administrative, 25 
coordinating, 13-17, 58-59, 299, 

420-423 
interdependence of, 13, 54 
types of information needed on, 26, 

65 
Business control, 

executive corporate group, 21 
general officers', 24-25 
junior executives', 25-26 
owner's, 21 



Capital, 

additional, 6, 23, 295, 317, 348 

requirements, analyzed, 324-328 
Cash, 

disbursements, 308-315 

receipts, 301-308 
Chart, 

budget procedure, 394 (insert) 

graphic, accumulated sales and col- 
lections, 304 

organization, 
corporation, 21 

manufacturing business, 275, 277 
Collections, 

and sales chart (graphic) , 304 

period, 303-305 

report, monthly, 321 
Comparative balance sheet, 351, 369 
Comparative profit and loss state- 
ment, 363, 371 
Corporation organization chart, 21 
Credit, 

building up bank, 32 

"reserve line," at bank, 323 

D 

Department store, 

departmental merchandise plan, 239 
Disbursements, cash, 308-315 

E 

Employees, 

cooperation with, 41-42 

demand for, 59 

desirable working conditions, 178- 

179 
housing of, 171, 182, 306 
transferring, 271 
welfare, per capita cost, 183 
Equipment (See "Plant and equip- 
ment") 
Estimated and actual balance sheets, 

compared, 369 
Estimated and actual profit and loss 
statement, compared, 371 



INDEX 



469 



Estimates, (See also "Budgets") 
as working program, 7, 8, 48 
central control of, 393, 421 
comparing, 6, 19, 307, 369, 400 
departmental, 5, 40-41, 50, 173,204, 

223, 233, 255, 258, 291, 300, 312, 

319, 331, 338, 366-367, 421 
in terms, 67 
items used in, 68-69 
"key" items in, 69-70 
responsibility for preparing, 36-38, 

71-72, 223, 262, 290, 312 
selling expense, need of, 88, 312 
Executive, 
chief, 24, 47, 375, 427 
control, centralized, 20-21 
control, decentralized, 18, 19, 26, 

192 
cooperation needed, 17, 41-42, 374 
departmental, duties of, 37, 52, 61, 

377 
general manager, 375 

assistant to, 376-377, 378, 380, 394 
in charge of budgetary procedure, 

7, 39, 44, 49-51, 177, 204, 262, 

289, 293, 317, 319, 368 
junior, duties of, 25-26 
periodic reports by, 8, 24, 176 
staff assistant as, 50-53 
Expense, 

administrative, 274, 279, 287-288, 

388 
allocation and business organiza- 
tion, 280-281 
allocation basis, 283-285 
auxiliary, 274, 286, 312 
budgets, 273-294, 299, 312, 360, 
365, 386-391, 459-463 

control of, 289-290, 294, 387-391, 
419-423 

form of, 291-292 
classified, 274-276, 294 
commercial, allocating, 279-280,283 
corporate, 274, 288, 291, 312 
direct, 276-278 



Expense — Continued, 

financial, 285-286, 291 (See also 
"Finances") 

indirect, 276-278, 285 

manufacturing (See "Manufactur- 
ing expense") 

"miscellaneous," budget of, 202- 

203,395 
not to be allocated, 281-282 
problems, 273 
reports, monthly, 292-294 
salesmen's, 94, 100 
shipping, 95, 97, 98, loi 
welfare, 185 



Factory (See "Production") 
Federal Budget Act, 439-449 
Finances, 
accounts receivable, 301, 303-305, 

322, 328, 342-343, 352, 354 
bank loans, 316-319, 325, 328, 334, 

340, 346, 350, 356, 367 
budget, 295-332, 340, 367, 391-392 

control of, 319-321 

preparing, 264, 317-319, 330-332 

vs. business cycle, 328-329 

vs. department budgets, 300, 301 
cash balance, 297, 303, 316, 349-352 
cash disbursements, 

form of estimate of, 312-314, 347, 

391 
items for, 315 
methods of estimating, 314-315, 

331,340 
cash period, length of, 322-323 

cash receipts, 
basis of, 303-305 
determining, 301-303, 305, 331, 

391 
sources of, 305-307, 322 
collection period, 303-305 
collections, estimate of, 319 
debts, allowance for bad, 302, 343 
expenses, disbursements for, 312 



470 



INDEX 



Finances — Continued, 

methods of, 32, 301-303, 330 
planning, 16, 65, 88, 233, 295-297, 

324, 330, 420, 423 
planning, long-time vs. short-time, 

297-298 
purchases, 

merchandise, 309 

production purposes, 310-312 
requirements, determining cash, 

298-300, 324 
requirements of, 77-78, 228, 274, 

295,317,418 
statements, preliminary estimates 

of, 392-393 
Finished goods (See "Production") 
Forecasting, 

based on statistics, 83 

defined, 3 



Industrial engineering, 

defined, 3 
Inventory, (See also "Material") 

estimated, 213-215, 220, 230, 
241,360,410 

method of determining, 212, 216, 
219 

"normal," 216, 220, 235 

periodical, 259 

perpetual, 212-217 

planning, statistics of past periods 
in, 215-216 

physical, 215-218 

report, monthly, 407-409, 414 
Invoice, 

purchase, classified, 232-234 



Labor, 

budget, 165-177, 208, 380, 382 
control of, 177 
form of, 176 
preparation of, 173-176 
report, monthly, 175 



Labor — Continued, 

cost, 174, 176, 265, 310, 381 
indirect, a manufacturing expanse, 

173,189,310 
pay-roll, 

budget of, 1 71-173, 202 
objections against budget of, 

172 
vs. expense budgets, 289 
requirements, analyzing, 166-168 
requirements vs. production and 

labor policies, 1 69-1 71 
standard rates, 168 
purposes of, 169 
turnover, determining, 184 
Law, budget, 
federal, 439-449 
state (Ohio), 450-455 
Ledger, plant, 253-255, 258 

form, 254 
Loans, bank, 

financial program for, 318 

M 

Manual on budget procedure, 42, 374- 

395 
Manufacturing business, organization 

chart, 275, 277 
Manufacturing expense, (See also 

"Production") 
budget, 188-209, 208, 250, 300, 310, 
382-383 

control of, 206 

preparation of, 203-206 

report, monthly, 205 
classified, 190-192 
defined, 189-190, 274 
depreciation as, 281 
distribution of, 194-196, 202, 256, 

276, 278-279, 285 
estimated, 188, 197, 206, 382 
machine rates, idle and overtime, 

200 
machine rates, modified, 202 
packing cost as, 96 



INDEX 



471 



Manufacturing expense — Continued, 
requirements determined, 192-194 
standard rates in, 188, 196-198 
method of establishing, 198-200 
vs. production, 201 
Market, 
analysis, 61-63 
conditions affecting budget period, 

33 
fluctuations affecting sales, 85 
Materials, (See also "Labor") 
basis of inventory control, 151 
budget, 154-164, 207, 310, 346, 383- 

385 

control of, 163-164 

form of, 160-163 

preparation of, 158-160 

report, 161 

vs. purchasing policy, 155-157 
estimate, need for, 145, 159, 168 
requirement, by commodities, 145 
requirement, by ratios of former 

periods, 147-148 
requirements yj. inventory, 149-151 
standard rates, 148, 158 
stores balance, sheet, 153 
stores budget, 157, 202 
stores vs. expense budgets, 289 

N 

Non-commercial enterprises, budget 
system, 425-438 

O 

Oflficers, 

general business, list of, 25 
Ohio, 

administrative code for, 450-455 
Operations, summary of, monthly, 41 1 
Orders, 

purchases, 230, 232 

implied, classification of, 234, 410 
Organization charts, 

corporation, 21 

manufacturing business, 275, 277 



Planning, 

business operations, 3-4, 329 

classified, 3 

department, 7-8, 136, 159, 166, 173, 

262 
equipment and personnel, 15 
estimates needed for, 27, 55, 210 
Plant and equipment, 
additions, 246, 249, 257 
betterments, 246, 249, 257 
budget, 245-272, 345, 385-386 

contents of, 261, 264, 272 

form, 263 

preparing, 261-262, 312 

report, 269 
charges, capital vs. revenue, 250 
charges, maintenance, 250-251, 253, 

257 
construction, costs of, 267-268 
depreciation, 248, 255-256, 258, 261, 

345, 354 

engineer, functions of, 260, 262, 264 

equipment, use of standard, 270-271 

expenditures, 

classified, 245-246, 266 
data controlling, 251-253, 272 
requisitions for, 265-267, 272 
reserve account, 268-270 

experts, information by, 258-260 

plant ledger, 253-255, 258 
form, 254 

repairs, 246-247, 254, 256, 258, 261, 
267, 273 

replacements, 246, 248, 273 

vs. volume of production, 256-258 
Procedure, budgetary, 

budgets, branch and division, 370- 
372 

chart, 394 (insert) 

dates for submission of estimates 
and reports, 394 

disadvantage of decentralized, 44- 

45 
. firgt steps towards, 28-29 



472 



INDEX 



Procedure, budgetary — Continued, 
"general budget," 370 
interdepartmental, manual for, 393 
manual on, 42, 374-395 
modern tendency towards, lo-ii 
outlined, 5-8 
plant and equipment, executing 

budget of, 265, 271-272 
supervisor for, 5-6, 49 
Production, (See also "Manufactur- 

ing") ^ 
basis of inventory control, 130-131 
budget, 124-144, 379-380 

preparation of, 139-140, 307 

relation of to sales budget, 124 
calculating, 134-135 
capacity vs. sales estimate, 125-127 
control vs. pplicies, 124-125 
control, review and summary of, 

206-209 
cost, i36-i;^8 
economical run, 133-134 
> estimate, inventory schedule and, 

128-130 
finished goods budget, 207, 228 

report, 141, 407-409 
inventories, monthly report, 414 

balance of stores sheet, 153 
items, 69, 86, 146, 167 
maintaining uniform, 17 
margin of safety, 132-133 
period, 31, 131 
reducing, 6 
requirements determined, 73, 127, 

258 
special orders, control of, 138-139 
unit costs and volume of produc- 
tion, report, 413 
vs. sales, 14-15, 75, 416-417, 422 

form of estimate, 73 
Profit, 
estimated, 75, 87, 362 
gross, on sales, 362-364 
maximum gross, 76 
net operating, 365, 405 



Profit and loss, 

balance sheet, relation to, 266-267 
causes of, 15-16 
comparative form, 363, 371 
cost of goods sold, 360 
expenses, 

non-operating, 361 

operating, 360-361, 364, 367 
income, non-operating, 361, 365 
manufacturing expense, as, 196, 200 
net income, 365 
notes receivable, 361 
reports, control of financial, 368- 

370 
sales, returns from, 359 
statement, 213, 251, 255, 289, 329, 

332-334, 338, 348, 352, 359-373 

contents of estimated, 359, 365 

preparing estimated, 367-368 
Purchases, 

budget, 210-227 

control of, 223-227 

report, 225 

vs. merchandise policy, 235-238 
data, classified, 230-235 
deliveries to stock, 220-222, 226, 

228, 230, 236, 242 
estimate, preparing, 222, 232, 242, 

292, 309 
inventory, types of, 212-216 
payments for, 228-230, 309-312 

form of estimate, 231 
requirements, 211 
vs. sales, 210, 310 



Receipts, 

additional, 6 

estimated, 78, 307-308 
Records, 

accounting, 34, 40 

departmental, 8 

finished goods, 135 

materials, 152-155 

objections to studying past, 19-20 



INDEX 



473 



Records — Continued, 

plant ledger, 253-255 

supplementary, importance of, 233 
Reports, 

administrative (See "Reports, ad- 
ministrative, below") 

advertising appropriation, monthly, 
121 

advertising expenditures, 122 

cash disbursements, 323 

cash receipts, 322 

collections, 321 

comparative, 27, 34, 40, 163, 187, 
293, 320, 400 

construction cost, 267 

control, use of, 102-105, 226-227, 
272, 294 

expense appropriation, 293 

finished stock, 141-144 

from sales units, 81 

inventories, 414 (See also "stock" 
below in this list) 

labor budget, monthly, 175-176 

manufacturing expense, 205 

materials, 161 

merchandise plan, 240 

net profits, 405 

operations summary, 411 

plant and equipment appropria- 
tions, 269 

purchases, 225, 229, 232 

responsibility for, 38-39, 262, 370 

sales, 402 

selling expense, 103, 403 

statistical, 333 

stock, 407 

comparative, 408, 409 

unit cost and volume of production, 

413 
used in purchases budget, 242-244 
welfare expense, monthly, 185 
Reports, administrative, 396-415 
classified, 396-397 
essentials of executive reports, 397- 

401 



Reports, administrative — Continued, 
factory inventories, 415 
information, 

actual performance, 398 

estimated performance, 399-400 

past performance, 400 
needed, 396 

net profits, monthly, 406 
operations, monthly summary of, 

412 
production control, 410-415 
sales control, 401-404 
selling expense, monthly, 404 
stock, monthly, 410 
summary, monthly comparative, 

410-412 
types of, 401-415 
unit costs, 415 
vs. executive, 397 



Salary budget, state university, 434- 

435 
Sales, 

analysis, 63-64 

anticipated, 57-59, 132 

budget, 54-86, 207, 241, 299, 377- 

379 
campaign, 87 
data, classified, 66-67 
estimate, 

manufacturing business, 59-60, 

67,74 
mercantile business, 58, 301-302 
need for, 55-56 

revision of, 75-78, 82, 224, 379 
threefold basis of, 60-65, 418 
vs. inventory requirements, 72- 

74,213 
expense (See "Selling expense," be- 
low) 
information, 54-55, 65-67 
items, 68-69, 76, 85 
office expense, 92-93, 100, 273, 364 
orders vs. shipments, 82 



474 



INDEX 



Sales — Continued, , 

planning, 3 

problems, 84-86 

program, 78-80, 184, 211, 230, 238, 
417,419,422 

reducing, 6, 353 

report, 402 

vs. collections, 302-303 
chart (graphic) , 304 

vs. plant and equipment, 15, 59 
Selling expense, 

allocation of "drayage," 96 

budget, 87-105 
form, 103 

preparation of, 101-102 
report, 403 

classified, 91 

controlling, 88-90, 389 

defined, 90-91, 274 

distributed, 276, 283, 285 

method of estimating, 99-101 

ratio to sales, 364, 406 
Shipping, 

breakage in, 98 

expense, analysis of, 97 

expense, packing and, 95, 98, loi 
State Budget Act (Ohio), 450-455 
State university budget system, 430- 

437 
Stock, 

deliveries to, 221 

finished (See "Inventories," "Pro- 
duction") 
Stockholders, 
authority, 22, 27 
limit of direct business control, 22- 

23 

ownership vested in, 21 



Stores (See "Materials") 

Summary of operations, monthly, 41 1 



Transportation, 

freight out, expense of, 96-97 
warehouses and branch depots, 98 
Turnover, 

inventory and, 218-220 
merchandise, 

calculation of, 217-218 
estimating, 241 
rate of, 362-366 
period, length of, 30-31 
Trust company budget system, 456- 
465 

U 

Unit costs and volume of production, 

report, 413 
University budget system, 430-437 



Volume of production and unit costs, 
report, 413 

W 

Welfare expense, 
budget, 178-187 

control of, 186-187 

form, 185 

preparation of, 186 

report, form, 185 
classified, 179, 186 
estimating, 181-185 
per capita cost method, 182-184 
vs. departmental expenses, 1 80-1 81 
vs. labor cost, 178 



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